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The Boston giant announces findings to justify its surprising embrace of stocks but skeptics say Fidelity is under pressure to conform with rivals T. Rowe Price and Vanguard Group
September 27, 2013 — 4:56 AM UTC by Brooke Southall
Brooke’s Note: I spoke with a handful of non-Fidelity sources (and one brave one on the record) for this article and the more I heard, the more confused I became. You need the spatial mental capabilities of Euclid to follow all the arguments about the right way, morally, legally and technically, to set and forget target date allocations and their glide paths. What is clear is that Fidelity just made a pretty big relative shift and like most companies, its move seems to be all about ideas and all about business, and good luck separating the two. What does this all have to do with advisors? Many advisors are big users of target date funds for one thing and anything that seems too simple and good to be true — probably is. Second of all, through its target date funds, Fidelity has installed itself as, in a sense, a grand advisor to 6.5 million investors. So a CIO at an RIA can see this as a window into what big-time competitor is doing, better defining its niche.
Nearly eight months after a blistering article in The New York Times, Fidelity Investments has promised to make some big changes in the way that it manages target date funds.
The Boston-based giant will invest the assets of the 6.5 million investors who own its target date funds much more aggressively in stocks while laying off of bonds. Its mix will look, on average, more like 60% stocks and 40% bonds rather than a more tentative fifty-fifty split. See: Viewing RIAs in a new light, Fidelity Institutional shifts from a top-down to a bottom-up emphasis to serve them.
Fidelity explains the surprising shift in its long-held conservative allocation by saying it reflects deep research into the reams of data at its fingertips — not only as the biggest player in target date funds with $175 billion of assets but also as the 401(k) king. This includes findings that investors have more of a stomach for risk than realized based on 2008 behaviors and that investors start investing sooner and live longer than previously thought. See: Fidelity brings its 401(k) muscle to RIAs with new product.
Bull market takes its toll
Still, industry experts are quick to point out that Fidelity is the one certain beneficiary of the change and that its timing need be noted. Fidelity tends to earn more fees when it invests in equities, where fees are highest. Fidelity uses its own mutual funds for the bulk of its investment management of target date funds.
Even more important, critics say, the long bull market in equities is starting to take its toll on Fidelity’s relatively equity-averse target date fund managers.
“They lost (in target date fund performance) to T. Rowe and Vanguard in 2012 and they took a lot of flak for that,” says Ron Surz, president of Target Date Solutions in San Clemente, Calif. See: Big chill: Worried RIAs and other 401(k) leaders gather in Chicago in hopes of saving the goose. Surz is sub-advisor for SMART Funds offered by Hand Benefit & Trust, Houston. SMART are collective trust target date funds.
Big three oligopoly
Surz points to a Feb. 3 New York Times article, Target Date Funds at Fidelity Fall Short of Rivals to illustrate the heat Fidelity has been feeling on this delicate topic.
The article, leaning heavily on Morningstar Inc. data, identifies The Vanguard Group Inc., T. Rowe Price Group Inc. and Fidelity as essentially an oligopoly that controls the $500 billion-plus target date market — but Vanguard and T. Rowe handily outperformed Fidelity in 2012, largely on the strength of more aggressive tilts toward ever-surging stocks.
The article went on to say that Fidelity’s underperformance was exacerbated by its higher fees, a result of reliance on its own actively managed funds. See: The 401(k) industry braces itself for fruits of a CalPERS rethink that reflects a cut-the-crap mentality about active investing.
Still, it is notable that as of Aug. 22, T. Rowe Price launched new funds that recognize that some investors are more risk averse as a complement its core T. Rowe Price Retirement Funds, which had $88.1 billion in assets as of March 31.
T. Rowe will allocate 42.5% of the new funds’ assets in equities at the named retirement date, compared to 55% for the existing Retirement Funds series.
The Times article pointed out that a nadir of sorts was reached in the fourth quarter of 2012 when 13 of 14 Fidelity target date funds performed worse than 75% of its competitors’.
The ugly result for Fidelity was less inflows to its target date funds than either T. Rowe and Vanguard.
As of Aug. 31, the total assets under management for Fidelity Freedom Funds stood at $174 billion, including $18.8 billion in Fidelity Advisor Freedom Funds, from $152 billion in assets under management for Fidelity Freedom Funds, including $16 billion in Fidelity Advisor Freedom Funds as of the same date the year before.
After original publication of the article, I was able to interview Andrew Dierdorf, co-portfolio manager of Fidelity Freedom Funds. He reiterated some of the points made by his company’s spokeswoman below. His response to expressed concerns in this article about how much competition from other players plays on Fidelity’s pivot on stock allocation was to say that all decisions put “shareholders” first. shareholders in this instance are investors in the target date funds. “We’re focused on shareholder outcomes.”
He says that the low rates on fixed income bode badly for the returns investors need over the long haul to achieve their personal retirement goals and that stocks look “fairly valued” which is to say that they should perform according to historical norms. The stock market tends to perform in the 5 percent to 7 percent range over long periods and he says that Fidelity believes that — over a 20 year period — the market can reasonably be expected to hold true to that norm.
Stomach for the storm
Nicole Goodnow, Fidelity spokeswoman says that her company has a history of doing comprehensive reviews based on its data on a periodic basis, and this latest adjustment in allocation was a result of that.
For one thing, she says, the study found that small investors have more stomach for risk — as proven by a giant sample of Fidelity data from 2008-09 — than it had built into its thinking before. “They stayed in and they didn’t reallocate funds,” she says. “Investors are reacting as they should.” See: Of Trumpets and Tulips: Is time diversification a myth or reality? Does time horizon affect the tolerance for risk?.
Knowing that investors can ride out the worst storms means that Fidelity doesn’t fear (as much) that a heavier stock allocation in bad markets will induce investors to run for the lifeboats at just the wrong time.
Another factor is the stock market in the here and now: In other words, Fidelity is investing more in stocks because it believes stocks are priced attractively. The company has even expressed on its website that the S&P 500 could be poised for a massive bull run”:https://www.fidelity.com/viewpoints/active-trader/a-bullish-chart?ccsource=email_monthly.
Round and round it goes
The third factor is a better understanding of when investors start and conclude their investing. Fidelity is pegging the start at about 25 years old, which is younger than previously presumed.
“In general, Fidelity believes that starting points matter, and that the company’s secular capital markets outlook informs its asset allocation positioning within the glide path,” the company states in a release.
Goodnow adds that Fidelity is also getting a better sense of just how much longer people are living — way past 80. This makes time horizons longer, which means that greater exposure to equities make more sense.
For example, up until now, Fidelity tended to have a 48-year-old 73% invested in stocks. Now it’s going to be 90%. Another example: Somebody who is 85 years old would have only been invested 20% in equities. Now it’ll be closer to 24%. The changes will be made by Fidelity between now and the end of the year. See: A refresher on how an advisor should approach the needs of clients as they near retirement.
Ironically, the smoothing of the glide path comes at a time when glide paths have been criticized for not being conservative enough. See: Why target date funds fail in the one area they’re supposed to succeed — downside protection.
Most crucial five years
Indeed, Surz says this lurch toward stocks will almost certainly help Fidelity but that it is questionable as far as stewardship of retiree money goes.
Fidelity, he says, will almost certainly realize better returns and gain better accolades from Morningstar by upping its stock allocation because, indeed, stocks to tend to outperform bonds in the long run and these funds are, after all, retirement assets.
The reason that this more aggressive approach — by T. Rowe, Fidelity, Vanguard and others — isn’t prudent is because the fate of retirees is tied so closely to how their fund performs in the five years leading up to retirement. If that period coincides with a downturn in the market then the investor ends up in rough shape, making all the long-term charts in the world useless, according to Surz.
“The No. 1 objective is: don’t lose my money — especially when I’m 70 years old. By investing aggressively, you are swinging for the fences and maybe you’ll get it right, but there are no do-overs.” See: An X-ray of one affluent, educated and sophisticated investor’s portfolio shows how it was chewed up by fees.
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Top Executive: Joe Mansueto
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