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Target-Date Funds: Fees Continue to Fall While Flexibility Powers Performance

NEW YORK (MainStreet) Target-date mutual funds provide an elegant solution for investors looking for a prudent way to save for retirement. Many advisors don't like them if widely adopted, these funds could eliminate a major portion of their practice, and profits. But the growth of such funds-of-funds is undeniable.

Target-date mutual funds, comprised of investments automatically adjusted for a retirement year goal, now account for $650 billion in assets as of March 31, according to Morningstar research.

Also See: Some of the Richest Retirees Are "Public Pension Millionaires"

In the first quarter alone, investors poured an additional $18 billion into the funds. And fees continue to fall, with built-in investment costs lower for the fifth year in a row. The industry's average asset-weighted fee stood at 0.84% at the end of 2013, down from 1.04% in 2008.

Also See: Guaranteed Return Retirement Plans Gain Popularity

"Part of that movement comes from a longer-term trend favoring lower-priced index-based investments within target-date funds," writes Janet Yang, a senior fund analyst for Morningstar, in the report. "The Fidelity Freedom Index series, for instance, now holds the mantle of lowest-priced series with its 0.16% asset-weighted fee, replacing Vanguard -- with its 0.17% asset-weighted average expense ratio -- as the cost leader."

Fidelity, T. Rowe Price and Vanguard are the "do it for me" mutual fund big dogs, with a combined market share of nearly three-quarters of all target-date fund assets.

Index funds continue to thrive, as efforts to beat the market persist in failing. Morningstar's analysis of target-date funds suggests that actively-managed strategies have underperformed for each of the last three years just as they have for the investment industry as a whole.

However, target-date fund managers that are given a bit of flexibility in their management of the funds have had a bit of success when compared to more rigidly structured competitors. Having the ability to make shorter-term tactical adjustments to their underlying investments has enhanced performance.

"Tactical management has intuitive appeal since it allows managers to attempt to avoid frothy areas of the market or jump into asset classes that appear poised for a rebound," Yang says. "And while academic and industry research have shown it's difficult to consistently make additive market-timing calls, so far, many target-date managers with tactical leeway have delivered strong results relative to peers."

But few money managers eat their own cooking. Morningstar reports the vast majority of target-date fund managers don't take a high stake in their own strategies. Only one manager -- Hans Erickson of the TIAA-CREF Lifecycle fund -- has more than $1 million invested in a single target-date fund within the group he manages.

--Written by Hal M. Bundrick for MainStreet

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