During this year's choppy market, many mutual-fund investors have decided to stop surfing each wave and opted instead for the Wall Street equivalent of an ocean freighter.
While their performance isn't exactly sexy, these funds do offer a smoother ride in turbulent markets than the average equity fund. Called lifecycle funds - a moniker that cuts across a range of categories - they meet a growing demand for ready-made diversification and simplicity, especially among investors planning for retirement. They're based on the idea that for long-term investment success, it's more important to apportion your assets than to select stocks or invest at the right time.
"Lifecycle funds are gaining traction with 401(k) plans because they increasingly serve as a default option for younger workers," says Ross Frankenfield, an analyst with Financial Research Corp in Boston. "It's a good way for companies to discharge their fiduciary obligation without exposing workers to excessive risk in their nest eggs."
Lifecycle funds also attract experienced investors who want a "one-step" solution without having to fret about asset allocation issues or periodic rebalancing, according to Ned Notzon, chairman of T. Rowe Price's retirement funds advisory committee. "They make a solid core holding around which you can spin spicier types of stocks or funds."
Those benefits may explain their growing popularity. Assets in lifecycle funds have swelled to some $150 billion, an increase of more than 50 percent since the end of 2003, handily outpacing broad fund industry growth, according to Financial Research Corp. Much of the increase comes from corporate retirement plans whose monthly contributions tend to follow a steady pattern.
Following the private sector's lead, the federal government is about to introduce lifecycle investing to its employees. Beginning next month, some 3.4 million participants in the federal Thrift Savings Program will be able to enroll in a series of funds with target maturities every 10 years beginning in 2010. The funds, managed by Barclays Global Investors, one of the nation's largest index-fund managers, are designed to coax federal employees to be more venturesome in their investment choices.
There are two kinds of lifecycle funds: those that tie their asset allocation formula to a specific date, typically an investor's retirement year, and those that build their asset allocation around a predetermined level of risk. The first variety, known as target-date funds, include T. Rowe Price's Retirement 2020 and American Century's My Retirement 2045 funds. Both gradually tilt their stock/bond mix from mostly equities in the early years toward fixed-income investments as the target date nears.
Conversely, managers of target-risk funds, such as MFS Growth Allocation Fund and American Century One Choice Portfolio: Moderate, preserve the same level of risk by periodically tweaking the asset mix. They shift money from areas of the market that look pricey to those that look cheap.
That's hardly new. The very first mutual funds - called balanced funds - used a similar strategy. But unlike balanced funds, which employ a one-size-fits-all approach, lifecycle funds often come in multiple flavors: conservative, moderate, and aggressive portfolios. That way investors can choose their risk tolerance and recalibrate over time, switching from one portfolio to another within the same fund family.
Most lifecycle funds have a "fund of funds" structure that often holds about six to 12 offerings from the same fund family. Each portfolio represents a broad range of asset classes and investment styles linked to its long-term investment objective. MFS Investments, for example, has four asset-allocation funds that invest in as many as 11 underlying MFS funds including small cap, mid-cap growth, large-cap value, and international offerings. Each fund has a distinct risk/reward profile that is periodically rebalanced to assure that no one or two investment styles or asset classes predominate. Less than three years old, the four funds sport average annual returns of 5 to 9 percent - and have already garnered more than $4 billion in assets.
The fund-of-funds approach, while a strength in many ways, can also be a weakness, critics point out, because they rely on the offerings of a single fund family. So a lifecycle fund could diversify by buying a mutual fund that's sub-par. But lifecycle advocates argue that the advantages of disciplined allocation outweigh the disadvantages of any one fund.
"Our focus is always on assuring the right top-level mix between various equity styles and bond maturities," says Joseph Flaherty Jr., senior vice president with MFS. That approach takes most of the emotion out of decisionmaking, he adds. Unlike most investors, who hate to shed winning stocks, "automatic rebalancing forces us to recycle money from top performers to out-of-favor groups."
While target-date funds become more conservative as an investor matures, not all march to the same beat. T. Rowe Price's eight retirement funds, for example, reach their most conservative allocation 30 years past the expected retirement year, when stocks drop from 55 percent to 20 percent of the total portfolio. Fidelity's Freedom retirement funds, on the other hand, downshift to a 20 percent stock allocation within a few years after retirement.
Most investors trim their equity exposure too much during post-retirement years, says Mr. Notzon. "If you expect to keep pace with the rise in the cost of living and increased longevity, you should keep at least half of your portfolio in equities during the initial retirement years."
In selecting a lifecycle fund, investors should compare offerings from several families, analysts say. Many of these funds are too new to have a five-year track record, but a one- or three-year record can be revealing. A family with a superior record in stock-picking might not match that skill in bonds, or vice versa. Funds with a similar risk target can vary significantly in their asset-allocation formulas. Some might be too cautious to reach their long-term investment goals. Others may have high expense ratios, detracting from future returns. Management fees and expenses are generally higher for lifecycle than for balanced funds, which average 1.3 percent, according to fund tracker Morningstar. While fund-of-fund managers justify their higher fees by the extra layer of management oversight required, some fund families such as Vanguard and T. Rowe Price don't tack on any extra fees.