For three years, the mutual funds in Fidelity‘s flagship retirement franchise have outperformed at least 85 percent of their competitors, reversing a decade-long trend of subpar performance.
And yet client money has continued to flow out of the firm’s Freedom Funds as retirement plan sponsors shift workers’ savings to rivals in the target-date fund business.
While deposits in the trillion-dollar sector have surged, Fidelity has seen nearly $16 billion in net withdrawals over the past four years, according to research firm Morningstar.
The exodus stems in part from unease with the way Boston-based Fidelity has boosted performance – by ramping up risk.
Since a strategy overhaul that took full effect in 2014, Fidelity has substantially increased exposure to stocks, including those from volatile emerging markets. The firm also scrapped a long-held belief of sticking to pre-set allocations of stocks, bonds and other assets in target-date funds.
Instead, Fidelity portfolio managers now try to time market shifts, for instance by moving billions of dollars out of money-losing commodities bets and into Chinese stocks and U.S. tech shares, regulatory filings show.
Such changes have worked well in the second-longest running bull market in U.S. history, but they expose investors to bigger losses if the funds’ increasingly volatile assets head south.
In the 1990s, Fidelity helped pioneer target-date funds as a prudent method to diversify investments and automatically dial down risk as participants age. The fund names typically include a projected retirement year – the target date.
Today, many target-date fund managers have turned to riskier investments to boost returns, and Fidelity has gone further than its peers, said Ron Surz, president of research firm Target Date Solutions.
“These funds with high concentrations in stocks are a time bomb,” Surz said.
The sector is even riskier today than during the 2008 financial crisis, when some funds dropped more than 40 percent, he said.
Fidelity spokesman Vincent Loporchio said today’s American savers can handle more risk because they retire later and live longer, allowing more time to recover losses.
“The Freedom Funds are a lifetime savings solution,” he said, that”deliver exceptional performance for shareholders taking appropriate risks.”
A recent global market sell-off underscored how Fidelity’s growing appetite for risk could amplify investor losses.
The Freedom 2020 Fund – for investors two years from retirement – fell 6 percent between Jan. 26th and Feb. 8th, performing worse than 81 percent of competitors’ similar target-date funds, according to Morningstar.
The sharp downturn reflects Fidelity’s decision to keep 60 percent of 2020 investors’ money in stocks compared to an average of 40 percent in similar funds for older savers, according to Morningstar.
The 2040 fund, for mid-career savers, tumbled 9 percent during that period, lagging 87 percent of rivals, after outperforming almost all competitors over the past year as stocks generally surged. The 2060 fund for young investors did better, beating 60 percent of rivals during the market sell-off.
Loporchio said such short-term swings do not reflect what Fidelity’s retirement savers will see over the long term. With its 2014 strategy changes, Fidelity needed to address a longstanding problem with underperformance of Freedom Funds, Loporchio said.
“When Fidelity products yield disappointing returns, we work relentlessly to improve them,” he said.
In the decade before the changes, Freedom Funds largely failed to beat or match their internal benchmarks, set by Fidelity, over one-, three-, five- and 10-year spans, according to a Reuters analysis of the firm’s performance data. Had the funds been a sports team, their record against benchmarks would have been six wins, 40 losses and one tie.
About 6.2 million Americans have about $224 billion invested in Freedom Funds, Fidelity’s largest retirement fund franchise. The funds account for about 10 percent of the firm’s assets under management and generate fee revenue approaching $1 billion annually.
But the funds’ market share has plunged to 21 percent of total target-date fund assets, down from 43 percent at the end of 2008, according to Morningstar data.
Of the top five target-date providers, Fidelity was the only one to have net withdrawals in 2016 and 2017, according to Morningstar data. By contrast, the target date industry as a whole racked up $129 billion in net deposits during those two years.
