Markets

Russell Target Date Metric - A New Way to Chase Performance?

By Allan Roth

Updated on: March 1, 2010 / 10:54 AM EST / MoneyWatch

Russell Investments recently announced their rankings of target date mutual fund families. The press release they issued shows the top and bottom five families over the past one and three years. The new system of rating fund families was announced in September of 2009 and is simply based on a portfolio of 60 percent stocks and 40 percent bonds. I'm usually all for simple benchmarks, but this new system actually creates a whole new way for investors to performance chase.

Background on Russell's new metric
Target date funds (TDFs) typically are fund of funds containing a combination of stocks, bonds, and cash that get more conservative over time. Most families have multiple funds with different years for the targeted retirement. Thus, a 2015 fund would be far more conservative than a 2040 fund.

All families are not alike, however. I spoke to Grant Gardner, Director of Portfolio Strategies at Russell, who identified Alliance Bernstein as one of the most aggressive TDF families, and Wells Fargo as one of the most conservative. An Alliance Bernstein 2020 fund (LTHAX) is roughly 77 percent in equities, while the Wells Fargo 2020 fund (STTRX) is only about 46% in equities, according to Morningstar. It's virtually a slam dunk that Alliance Bernstein will have higher returns than Wells Fargo in up markets, and Wells will perform better in down markets.

Russell's new methodology will simply rate all fund families based on the following three indices:

40% Russell 3000Â®,

20% Russell Global Ex-U.S. Index

40% Barclays Capital U.S. Aggregate Bond Index

My take on this new metric

My initial reaction was to love the new benchmark. Not only was it simple, it was, for all practical purposes, the moderate risk version of my son's second grader portfolio. But then I started thinking - Is it appropriate to just ignore the differences in asset class mix to rate a fund family? In fact, if I wanted to be assured that I'd have one of the best performing TDF families in the business according to this Russell metric, wouldn't I just start two families with one being the most conservative and the other being the most aggressive?

To test my theory, I went back to the Russell rankings and found that the aggressive Alliance Bernstein family was in the top five over the past boom year in the stock market, and that the conservative Wells Fargo family was in the top five over the awful three year period in the stock market. In actually, both families are far too expensive with mediocre performance for my taste.

Fund rating services such as Morningstar have gone to great lengths to compare mutual funds with similar characteristics. The company recognizes that comparing funds with different asset classes provided little data on how the fund actually performed versus its peers in the same asset class. Even with the more fair comparison of funds, Morningstar is quick to point out that one should not build a portfolio based on their performance ratings. This is simply performance chasing.

The new Russell metric, however, introduces a whole new way to performance chase. Consumers will be picking families heavily weighted in bonds in bad times only to be in the wrong asset classes when the market recovers.

Russell's response

I posed the question of performance chasing to Gardner, and he agreed the metric would lead to buying the hot asset class if that was the only metric being used. He noted that this should be only one of the metrics being used in selecting a TDF. He stated that Russell was partnering to an extent with Morningstar.

Morningstar's rating system

Morningstar rates individual target date funds rather than the whole family. I spoke with John Rekenthaler, CFA, who is vice president of research for Morningstar, Inc. He noted that Morningstar rates TDFs based on a more complex methodology using the following, with each carrying a 20 percent weighting:

Performance
Expenses
Underlying fund rating (since TDFs are fund of funds)
Management
Fund family stewardship

Rekenthaler said that even the 20% performance rating is adjusted for the volatility of the fund, rather than just using a simple absolute performance.

My advice

In my view, using the Russell metric that ignores differences in risk merely encourages consumers to invest in the stock market after it has done well only to bail after it tanks. While I like the simplicity of the Russell method, I will be giving it a zero weighting.

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Allan Roth

Allan S. Roth is the founder of Wealth Logic, an hourly based financial planning and investment advisory firm that advises clients with portfolios ranging from $10,000 to over $50 million. The author of How a Second Grader Beats Wall Street, Roth teaches investments and behavioral finance at the University of Denver and is a frequent speaker. He is required by law to note that his columns are not meant as specific investment advice, since any advice of that sort would need to take into account such things as each reader's willingness and need to take risk. His columns will specifically avoid the foolishness of predicting the next hot stock or what the stock market will do next month.

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