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MUTUAL FUNDS

Do you know what’s in your target-date fund’s portfolio?

By Mark Jewell
Associated Press / May 15, 2011

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Do you know what’s in the target-date mutual fund you’re counting on for retirement? It might be more than stocks and bonds.

Since the market crash of 2008, many fund companies have been adding alternative investments to their target-date portfolios. Commodities like oil, gold, corn, and soybeans are showing up in funds. So are real estate investment trusts and complex investing strategies that are more common among the hedge funds aimed at wealthy investors.

Some of these investments are volatile. That was clear last week, when oil prices fell 14 percent and silver dropped 27 percent.

But investors shouldn’t worry that the next plunge in commodities or other alternative investments will derail their retirement plans. Most companies that are adding them to target-date portfolios are doing so in small doses — typically 5 percent to 10 percent of a fund’s overall investments.

It’s important to know that adding alternative investments into target-date portfolios isn’t about beating the stock market. It’s about spreading risk across many types of assets and protecting against inflation. It’s in line with the target-date goal of building up savings over decades, and reducing the chance that a market decline will force an older investor to delay or scale back retirement plans.

The alternatives’ volatility makes them too risky for most individual investors because chances of a mistake — buying when prices are high, or selling when they’re low — are great. But their use in a broad, professionally managed portfolio “gives you an extra level of diversification,’’ says Wyatt Lee, a manager of target-date portfolios at T. Rowe Price, one of the companies expanding use of commodities.

Still, the use of these investments in target-date funds is relatively untested. The products, also known as lifecycle funds, originated 15 years ago, and now hold $341 billion in assets, according to Morningstar. They’re common in 401(k)s and other workplace savings plans.

Lynette DeWitt, a target-date fund researcher for industry consultant Financial Research Corp., is concerned about the addition of risk to the funds.

“What’s being billed as a risk protector is really a double-edged sword — these products are also risk creators,’’ DeWitt says.

Here’s a look at the alternative approaches companies have recently been taking with target-date funds:

■ Commodities. Fidelity’s Freedom 2050 fund — aimed at people now in their 20s and hoping to retire around midcentury — invests nearly 10 percent of its portfolio in another fund, Fidelity Series Commodity Strategy. Its holdings include oil, gold, soybeans and cocoa. That’s the highest investment in commodities by a target-date fund, according to a recent Morningstar study.

For the current or near-retirees in Fidelity’s 2010 fund, the commodities fund is 4 percent of the portfolio, reflecting the lower risk Fidelity believes is appropriate for older investors.

■ Real Estate. The T. Rowe Price funds, and those from other major target-date providers, own stocks of real estate investment trusts. These companies own and sometimes operate commercial, industrial and retail properties. Their portfolios are often diversified broadly across many types of properties and regions. But real estate is inherently volatile.

■ Hedge fund strategies. A few smaller target-date providers such as Putnam and DWS have been using “absolute return’’ or “market-neutral’’ strategies designed to succeed in an up or down market. These were pioneered by hedge funds. Managers load one part of their portfolio with stocks or bonds, and the other with alternatives such as options, futures, currency hedges, or “short’’ bets that certain stocks will lose value. When the conventional side rises or falls, the rest of the portfolio is supposed to move in the opposite direction. This is intended to balance out the fund’s performance, but slightly on the positive side.