4 August 2020

Near-Term Target Date Funds Suffer With Bond Market Woes

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The bond market’s poor performance in second quarter had a profound effect on near-term target date funds. Even the most conservative allocations saw considerable drops caused by concerns over the timing of when the Federal Reserve will scale back its bond-buying program.

This may have a significant impact on 401(k) participants - according to research by Vanguard  - nearly 31% of contributions to plans are allocated to target date funds.

In May, when the Federal Reserve indicated that it was considering a slowdown of its bond purchases starting as early as September, bonds saw a massive sell-off in May and June. The Barclays U.S. Aggregate Bond Index declined 2.3% during that period.

With the bond selloff, performance of target date funds also suffered, especially for near-term target date funds which are heavily-invested in fixed income. The Morningstar Conservative 2015 benchmark showed a decline of 2.2% for second quarter. The benchmark allocation calls for 30% stocks, 49% bonds, and 13% Treasury inflation-protected securities (TIPS).

During second quarter, TIPS showed the biggest declines at 7.1%. U.S. aggregate bonds declined 2.3%, high-yield bonds dropped 1.4%, and U.S. short-term bonds declined 0.1%.

This all came at a time when the equity markets were trending upward. U.S. Small-cap growth stocks were up 3.7% and U.S. large-cap value stocks were up 3.2% in second quarter.

Target-date funds more heavily weighted in equities or shorter-duration bonds fared better than more conservative offerings. Positive performance from equities helped to overcome any losses bond losses they may have experienced. And with shorter-duration bonds, which don’t pay as much on yields, as interest rates rise, they may pay a higher nominal rate.

It is likely that find managers will do more to diversify their fixed-income sleeves so that they can better weather bond market changes. 

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