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.