Alliance, Putnam Rejigger Retirement Funds

NEW YORK ( TheStreet) -- When the stock market crashed in 2008, most target-retirement mutual funds sank. That was a painful blow for investors who had viewed the funds as relatively safe retirement vehicles. Congressional critics called for changing the funds.

Now some managers are taking steps to ensure that their funds prove more resilient in difficult markets. Major fund companies that have introduced new risk-control approaches include Alliance Bernstein ( AB), Invesco AIM and Putnam Investments. It is too soon to know how effective the risk strategies will be. But they represent innovative steps that challenge long-held tenets of investing.

If the new systems succeed, they could encourage broad changes in target funds. The target funds are designed for people who plan to retire in certain years, such as 2020 or 2030. As the retirement date approaches, the funds automatically become more conservative, shifting assets from stocks to bonds.

Say a young person selects a 2050 fund. In the typical approach, the fund would begin with as much as 90% of assets in stocks. As the retirement date approaches, the allocation to stocks would fall year by year until it hit 50% or less.

To protect assets, Invesco AIM has scrapped many of the traditional elements of target funds. Instead of holding mainly stocks, AIM Balanced-Risk Retirement Funds emphasize other assets. Under normal conditions when no asset class seems particularly cheap, the funds keep 90% of assets in bonds, 30% in stocks and 30% in commodities. The numbers add up to more than 100% because the portfolios hold futures, which can be leveraged to increase the total exposure to each asset class.

Because of the big bond stake, the AIM funds could lag in stock bull markets. But the managers argue that they should protect assets in bad times and enable investors to obtain consistent results. "By avoiding serious losses in downturns, we can achieve attractive long-term returns," says Scott Wolle, manager of AIM Balanced-Risk Retirement Funds.

The AIM funds hold their same asset allocation until 10 years before the retirement date. Then the funds begin gradually shifting to cash. At retirement, 40% of assets would be in cash with the rest in stocks, bonds and commodities.

Retirees who use AllianceBernstein Retirement Strategies Funds could have most of their assets in stocks. But the company is introducing a new system to temper losses in downturns. For retirees, 20% of assets would shift out of stocks and into a fund designed to manage volatility. During normal times, the volatility fund would remain all in stocks. But when the market begins bouncing up and down, the volatility fund would start shifting from stocks to bonds. At times of extreme distress, the volatility fund could be all in fixed income, which would help to protect the assets.

By shifting to bonds, the retirement funds could lag during the early stages of a stock rebound, but AllianceBernstein managers say that they would outperform in downturns. "The idea is to provide a shock absorber that will enable us to deliver a smoother ride," says Tom Fontaine, AllianceBernstein's head of defined-contribution investment.

Why not just shift 20% of assets permanently into bonds? Fontaine says that moving to bonds will lower the expected long-term returns because stocks tend to outdo fixed income. But by putting some assets into the new volatility holdings, the funds can lower their risk without significantly changing their expected long-term returns.

To control risk, Putnam RetirementReady Funds are putting assets into the company's four new Absolute Return funds. Instead of trying to beat a benchmark such as the S&P 500, these funds aims to achieve fixed goals, outperforming Treasury bills by certain amounts. The most aggressive is Absolute Return 700 ( PDMAX), which aims to outdo Treasuries by 700 basis points, or 7 percentage points. The Absolute Return 500 ( PJMDX) aims to outperform by 5 percentage points.

Young people in Putnam's 2050 fund would have only small holdings in the Absolute Return funds, with most assets in conventional stock and bond funds. Retirees would have most of their assets in the Absolute Return funds.

In all cases, the Absolute Return funds aim to achieve their goals while taking as little risk as possible. That requires fund managers to limit stock holdings. At the moment, Putnam Absolute Return 700 has only 14% of assets in stocks. Most of the rest of the assets are in fixed income, including high-yield corporate bonds. Many of the junk bonds have been depressed since the credit crisis began, and they stand to produce double-digit returns this year, says Jeffrey Knight, Putnam's head of global asset allocation. "Right now we can earn the targeted return without a lot of participation in the stock market," he says.
Stan Luxenberg is a freelance writer who specializes in mutual funds and investing. He was formerly executive editor of Individual Investor magazine.