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Some target-date retirement funds are adding riskier assets

Invesco Ltd. and Pacific Investment Management Co. are adding riskier assets and complicated strategies in target-date funds as they seek to gain ground on Fidelity Investments and Vanguard Group in this fast-growing segment of the retirement market.

While sellers promote the funds as a simple choice for people who don’t want to pick their own investments, money managers are using inflation hedges and derivatives to bolster returns. That does not address target-date funds’ main issues: uneven returns and higher expenses, said Bob Pozen, a senior lecturer at Harvard Business School.

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Target-date mutual funds hold assets that become more conservative as employees age. Investments in the funds have swelled more than 380 percent since 2005 to about $343 billion.

“Some people are losing sight of the risk-management goal by adding all these additional asset classes,’’ said Jim Lauder, chief executive of Global Index Advisors. “If you devastate their portfolios, inflation doesn’t matter.’’

Invesco uses exchange-traded futures and some swaps on futures to invest in commodities, said Scott Wolle, of Invesco Global Asset Allocation. It also uses the derivatives to trade in six global equity markets and sovereign bond markets, including Australia, Japan, and Germany.

“There’s complexity in the guts of how we manage the portfolio but there’s a simple approach,’’ he said. “We’re trying to win by not losing.’’

Invesco’s target-date fund for those retiring in 2020 returned about 9.8 percent last year with dividends reinvested. The average target-date fund lost about 1.6 percent.

Pimco uses derivatives in its target-date funds to hedge against inflation, credit risks, and currency dislocations by purchasing options contracts, futures, or swaps, said the company’s John Miller.

“While the hedges do cost something in terms of putting them into the portfolio,’’ Miller said, “they have the potential to not only pay for themselves but they can and have been a source of out-performance, at least historically.’’ The firm’s target-date fund for those retiring around 2020 returned about 2 percent with dividends reinvested last year.

Target-date funds generally build capital by holding mostly stocks when an employee is younger but shift to more conservative assets such as bonds as retirement approaches and the need for steady income increases.

Fidelity Investments, Vanguard, and T. Rowe Price Group controlled about 75 percent of the target-date assets in 2011. The average fee for a target-date mutual fund last year was about 1.1 percent, according to Morningstar. Fees for the funds at Pimco and Invesco averaged 1.2 percent.

Workers may be better off with a so-called balanced fund that has 50 to 60 percent in equities and 40 to 50 percent in bonds because target-date funds generally have more moving parts and higher fees, Pozen said.

Margaret Collins writes for Bloomberg News.
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