Morningstar Advisor - December/January 2010 - 28

Gray Matters Committed Managers Families that have longtenured managers and high retention rates are likely to have the same team in place for several years. Series Name Avg. Manager Tenure Manager retention% American Funds Vanguard JP Morgan Vantagepoint T. Rowe Price MFS MassMutual Principal Putnam Schwab Fidelity Freedom ING Retirement TIAA-CREF Oppenheimer American Century John Hancock AllianceBernstein Fidelity Advisor Freedom Wells Fargo DWS 23.0 10.7 8.1 7.1 6.4 6.4 6.3 5.6 5.6 5.4 4.6 4.1 3.8 3.4 3.3 2.9 2.5 2.5 2.5 2.4 98.1 93.2 85.7 91.8 94.1 86.5 88.6 87.3 78.9 86.7 86.3 86.9 87.6 91.0 87.7 87.3 89.8 86.3 89.5 82.1 strong long-term performance do the most to align the managers’ own financial goals with shareholders’. Conversely, managers who are paid based on short-term goals may assume unnecessary risk to achieve returns that are meaningless to buy-and-hold shareholders, and managers who get paid to grow the funds’ asset bases may choose to go on a sales call rather than research a new investment. Of the 20 pay plans we studied for our target-date series reports, only six of them— American Funds, American Century, DWS, JP Morgan, T. Rowe Price, and Vanguard— base most of the managers’ compensation on generating peer-beating returns over the long term, which we define as four years or more. Disappointingly, four series received no credit at all for aligning their compensation plans with shareholders’ best interests. These series—ING, MassMutual, Principal, and Wells Fargo—offer so little detail about their pay plans in filings with the SEC that it was impossible to tell what criteria were used in determining the bonus payouts. The remaining 10 series based their pay on short-term returns. Little Skin in the Game 58 named managers of the target-date series that Morningstar studied, only two had investments greater than $500,000. One manager from TIAA-CREF had more than $1 million invested. Meanwhile, 33 of the 58 managers had no investment whatsoever. In three of the 20 plans, managers had difficulty investing directly in the target-date funds. Even so, it is telling that few target-date fund managers have demonstrated their conviction in funds by making direct investments— particularly as the public message from fund companies about target-date funds is that they, more than any other type of mutual fund, are appropriate for all retirement investors. It appears that, to a large extent, the managers of target-date funds are not as confident about such claims made by their companies’ marketing departments. Proper Parenting Manager-retention rate since 2004. Annualized through Dec. 31, 2008. Average manager tenure as of July 31, 2009. Another component of a target-date series’ overall rating is the Parent score. Half of the score is tied to corporate culture, 25% to board oversight, and 25% to transparency. A rating can be docked up to 25% if the parent firm has a poor regulatory history. Morningstar makes a qualitative assessment of the corporate culture at the asset-management company offering the series. A culture that exhibits best practices is one in which fund managers and analysts spend their careers at the firm, sharing in investor successes or failures. If the company’s funds do well, then the company attracts assets, grows its revenue, and manager compensation increases over the long term. In contrast, a corporate culture that is in flux because of a change in control, new executive leadership, a regulatory scandal, a raft of shareholder redemptions, or the inability of top management to set a consistent strategic direction is a cause for concern. Investing in target-date funds that are supported by investor-focused corporate cultures is especially critical given the decades that investors are expected to own the funds. Corporate Culture Investing in funds that are supported by investor-focused corporate cultures is critical given the decades investors will own targetdate funds. Of the 20 firms in our study, 13 have been graded on corporate culture by Morningstar. Fund Family Morningstar CorporateCulture Grade Funds Merged since 2005 Funds launched since 2005 American Funds T. Rowe Price Vanguard Fidelity AllianceBernstein American Century DWS John Hancock JP Morgan MFS Oppenheimer Wells Fargo Putnam Z Z Z X C C C C C C C C B 0 5 1 9 11 10 12 31 23 11 12 19 9 11 16 25 69 12 25 14 137 31 8 25 8 15 In addition to assessing management’s pay criteria, we also look at whether the target-date fund managers have invested in the series. Target-date funds are marketed as core holdings for investors, so we expected to see fund managers using these funds as the core of their own portfolios. Morningstar views best practices for fund-manager ownership as having the manager invest at least $1 million in a core fund that he or she runs. Not only does manager ownership demonstrate conviction in the investment process and in the fees charged, Morningstar has found that the more money a manager has placed into the funds that he or she runs, the higher the total returns are likelier to be. In the case of target-date funds, however, manager investment is severely lacking. Of the 28 Morningstar Advisor December/January 2010

Morningstar Advisor - December/January 2010

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