Sound Investing For Every Stage of Life
Target-date wars: Fidelity vs. Fidelity
Reprinted courtesy of MarketWatch.com.
Published: August 7, 2019
One of the best tools for working people who are saving for retirement is the target-date fund.
Most 401(k) and similar plans offer this option, which provides a modest amount of diversification among equity asset classes as well as a built-in mechanism for gradually reducing the risk of the portfolio as retirement gets closer.
But not all target-date retirement funds are the same, and I recently discovered an interesting comparison among Fidelity’s offerings.
As I was reviewing the list of investment options in a reader’s 401(k) plan, I realized that Fidelity offers two different versions of its target-date funds.
One version is what I think is the wrong choice for most investors. But this one brings more profits to Fidelity Investments. Not surprisingly, it’s the version that’s offered in most Fidelity-run retirement plans.
The other version is the right choice for investors. But it’s less profitable for Fidelity, sort of an “under-the-counter” product that’s rarely offered to retirement plan participants.
Fidelity is one of the few fund companies that offer target-date funds based on active management as well as similar funds with portfolios made up of index funds.
I’m a big fan of indexing (as opposed to active management), and I decided this would make an interesting comparison.
Here are two mutual funds managed by the same company, with identical goals. The only apparent difference is active vs. passive management.
I asked myself: How would this difference affect the funds’ expenses and performance?
For comparison, I chose two funds with target retirement dates of 2055. The bulk of these funds’ portfolios are invested in equities.
The difference between their names…just one word…is a detail likely to be overlooked by retirement plan participants.
The difference is costing lots of people lots of money.
When compared with indexing, active portfolio management has two major drawbacks.
• Active managers typically underperform their benchmark indexes. Thus their returns are usually less than those of the indexes.
• Active management adds expenses that are charged to investors, further reducing returns.
The academics say that the most reliable predictor of the performance of two similar funds is operating expenses.
And sure enough, Fidelity’s actively managed 2055 fund has higher expenses and lower performance than the index version.
Here’s a brief comparison:
Table 1: Short-term comparison of Fidelity 2055 target-date funds
|*Through July 31|
Over this seven-month period, the actively managed fund underperformed its index equivalent by more than a full percentage point. Roughly half that difference may be attributable to the higher expenses investors paid for that active management.
But the rest of the difference must be attributed to some other factor, and I think that is most likely the lower performance of the actively managed portfolio.
This underperformance is not a fluke of 2019, as we see in Table 2.
Table 2: Longer term comparison of Fidelity 2055 target-date funds
|Expenses||CRR 5 years ended 6/30/19|
The difference in 2019 appears to be due to relative underperformance of the actively managed fund. The difference in the longer term suggests the actively managed portfolio’s performance was better than that of the indexes. But the difference was not enough to cover the higher management costs.
At the end of July, Fidelity reported the one-year performance of the index version of the fund as 4.45%; the actively managed version had a one-year return of only 1.3%.
As noted in Table 1, the actively managed fund has attracted more than $3.2 billion in assets. That’s more than five times the assets in the index fund.
I can only speculate about the reason for that striking difference.
I think one reason is that, whether or not it is good for them, many investors continue to favor the hope that they might achieve superior performance from active management than from indexing.
But because the active version is obviously more lucrative for Fidelity, I’m guessing Fidelity has promoted it much more heavily and offers it in many more retirement plans.
That means that millions of participants in 401(k) plans have the wrong choice, not the right choice, available to them.
I want to advocate an easy fix: Require every retirement plan that offers an actively managed target-date fund to also offer the index-based version, if one is available.
This would be no burden for Fidelity, which routinely offers dozens of funds from which investors can choose. This would give investors a choice they deserve.
If the bookies in Las Vegas were taking bets on the long-term performance of actively managed funds vs. index funds, there’s no question in my mind which would be favored.
Early this year, a study concluded that over the 15 years ended Dec. 31, 2018, the S&P 500 index SPX, +0.55% outperformed 92% of all actively managed large-cap core equity funds.
Fidelity has created the product that the bookies would likely favor — the target-date fund based on indexing. Fidelity, and the retirement plans that use its funds, should at the very least give investors the choice to have the odds in their favor.
The situation I’ve described falls into the category of things that mutual-fund companies don’t tell investors…things that those investors really should know.
To find out what else is being kept from you, check out my latest podcast: “21 things mutual-fund companies won’t tell you.”
Richard Buck contributed to this article.