Hit or Miss? iShares' Addition to Target-Date ETFs

 |  Includes: TGR, TZD, TZE, TZG, TZI, TZL, TZO, TZV
by: Don Dion

On November 7, iShares, which is owned by Barclays (NYSE:BCS) Global Investors (BGI), announced the premiere of a new series of “target date” ETFs designed to help investors prepare for an anticipated need for funding, like college tuition or retirement. Each fund has a different investment time horizon, allowing individuals to select a fund that corresponds with the date that they anticipate needing the investment capital. As the fund’s target date approaches, the asset allocation shifts, providing a more conservative investment portfolio to help ensure the availability of the capital. While the popularity of mutual funds with similar target-date methodology will undoubtedly bode well for the eight new iShares funds, the passive indexing approach inherent to ETF models will require investors to keep a closer eye on both opportunities and opportunity cost.

While the new target-date funds represent a new strategy from the iShares family of ETFs, the target-date strategy is not unique to the investment arena or even the broader universe of available exchange-traded products. The iShares launch comes on the heels of a similar family of products introduced by TD Ameritrade last year. The TDX Independence funds have 2010 (NYSEARCA:TDD), 2020 (NYSEARCA:TDH), 2030 (NYSEARCA:TDN), 2040 (NYSEARCA:TDV) and “in target” (NYSEARCA:TDX) time frames, roughly half the target dates offered by iShares. The two families of products also differ in their construction: The TDX Independence funds are composed of individual equities and bonds, while iShares’ new offerings are designed as funds of funds, consisting solely of ETFs from the iShares universe of products.

The TDX and iShares approaches may be different, but the premiere of both sets of products can be seen as a play for a portion of the still-large retirement savings market. While 401(k) assets have been whittled down dramatically in recent months, the demand for retirement savings investment vehicles is still enormous by any standards. At the end of 2007, the Investment Company Institute (ICI) released data estimating the size of the 401(k) market to be approximately 3 trillion. As many companies have switched from pension-style plans to 401(k) programs in recent years, the responsibility of managing retirement savings has also fallen increasingly on individuals. Some professionals have turned to funds during this process in order to minimize the time and stress associated with investment allocation decisions and the possibility of costly investment mistakes.

The most popular arena for target-date investing has traditionally been that of mutual funds, a phenomenon that has become wildly popular in the last two decades. iShares’ announcement of its new products acknowledges the popularity of target-date mutual funds by noting that the release of the new ETFs coincides with the anniversary of the first target-date funds for institutional investors, BGI’s LifePath funds, launched in 1993. Of the $3 trillion worth of 401(k) plan assets at the end of 2007, $1.7 trillion were invested in mutual funds. According to ICI, the mutual fund portion of the 401(k) market has grown tremendously, from 9% in 1990 to 55% at the end of 2007.

With such a growing demand for retirement investment products, there is hardly any question of why TD Ameritrade or iShares would scramble for a piece of the 401(k) pie. In the funds’ accompanying press release, Noel Archard, head of U.S. iShares Product Research and Development at BGI, noted that “the new iShares target-date funds are well-suited to IRA rollovers or small-sized 401(k) plans [that] want to offer their participants an option that combines certain benefits of ETFs such as transparency with the benefits of target funds, which help mitigate common investor pitfalls such as poor asset allocation and failure to make portfolio changes over time.”

The new ETFs help to avoid this failure to adjust allocation, by shifting funds automatically. For example, the iShares S&P Target Date 2010 Index Fund (NYSEARCA:TZD) would initially allocate 52% of assets to equities and 48% to fixed income, while the iShares S&P Target Date 2040 Index Fund (NYSEARCA:TZV) would initially allocate 91% of assets to equity and 9% of assets to fixed income. Both funds shift assets from equities to fixed income as the target date approaches, to provide a more conservative portfolio, thus helping the participant to have the investment assets available when needed. TDX’s 2040 target-date fund begins with a 97% exposure to equity, which decreases to 10% by 2040.

The new iShares ETFs are meant to appeal to those investors seeking to remove human error from their allocation decisions. The underlying indices for the funds are created by S&P based on its yearly survey of target- date funds. S&P combines the raw data from the survey to produce the allocation basis for the new ETFs and create indices that represent a blend of target-date provider philosophies. This combination of indices could prove to be more conservative for investors over the long term than the individual equity approach used by TD Ameritrade could.

Not all funds, or ETFs, for that matter, are created equal, and some of the very factors that have made ETFs so desirable may prove harmful in a 401(k) investment strategy. While iShares’ survey-and-automatically-allocate strategy diminishes the impact of inevitable human error, it also prevents commonsense human intervention not offered by computer models. The method used by these ETFs is passive, and investors will sacrifice participation in certain sectors and trends not modeled by their target-date funds. While the new iShares target-date ETFs will remove some of the risk involved in do-it-yourself 401(k) investing, the one-size-fits-all philosophy may prove too conservative for some investors who want to take advantage of market fluctuations. Only time will tell how much of the 401(k) market the new ETFs will corner, but if the popularity of similar mutual funds is any indication, the new iShares target funds could capture the attention of buy-and-hold investors.