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Summary FFFDX offers investors a high expense ratio to go with a needlessly complex portfolio. Investors seeking superior risk adjusted returns could go with allocations as simple as SPY + any long term treasury ETF. By incorporating an enormous volume of other mutual funds the target date fund incorporates a higher expense ratio with suboptimal holdings. If the fund needs exposure to the total US market, they can ditch the complicated combination of funds and just use FSTVX (Disclosure: long FSTVX). Lately I have been doing some research on target date retirement funds. Despite the concept of a target date retirement fund being fairly simple, the investment options appear to vary quite dramatically in quality. Some of the funds have dramatically more complex holdings consisting with a high volume of various funds while others use only a few funds and yet achieve excellent diversification. My goal is help investors recognize which funds are the most useful tools for planning for retirement. In this article I’m focusing on the Fidelity Freedom 2020 Fund (MUTF: FFFDX ). What do funds like FFFDX do? They establish a portfolio based on a hypothetical start to retirement period. The portfolios are generally going to be designed under Modern Portfolio Theory so the goal is to maximize the expected return relative to the amount of risk the portfolio takes on. As investors are approaching retirement it is assumed that their risk tolerance will be decreasing and thus the holdings of the fund should become more conservative over time. That won’t be the case for every investor, but it is a reasonable starting place for creating a retirement option when each investor cannot be surveyed about their own unique risk tolerances. Therefore, the holdings of FFFDX should be more aggressive now than they would be 3 years from now, but at all points we would expect the fund to be more conservative than a fund designed for investors that are expected to retire 5 years later. What Must Investors Know? The most important things to know about the funds are the expenses and either the individual holdings or the volatility of the portfolio as a whole. Regardless of the planned retirement date, high expense ratios are a problem. Depending on the individual, they may wish to modify their portfolio to be more or less aggressive than the holdings of FFFDX. Expense Ratio The expense ratio of Fidelity Freedom® 2020 is .66%. That expense ratio is simply too high. Investors using a target date fund need to keep an eye on those expenses. It is possible to create a very efficient portfolio using only a few funds. Ideally the funds selected for building the portfolio would be selected for offering excellent diversified exposure at very low expense ratios. At the most simplistic level, an investor is looking for domestic equity, international equity, domestic bonds, and international bonds. If any of those had to be left out, the international bond allocation is the least important. In my opinion, there is no need to use both growth and value indexes. There is no need to individually use large, medium, and small-cap allocations. For instance, the Fidelity Spartan® Total Market Index (MUTF: FSTVX ) has a net expense ratio of .05% and offers exposure to the vast majority of the U.S. market. If you were building a target date fund from Fidelity funds, you could simply use FSTVX and eliminate all other domestic equity funds. This method would provide investors with a low expense ratio on the underlying domestic equity position and excellent diversification. That is precisely why I am including FSTVX as a holding in my portfolio. Holdings / Composition The following chart demonstrates the holdings of Fidelity Freedom® 2020: If you were making a target date fund, how many allocations would you need? Hopefully it wouldn’t be that many. Note that the holdings chart above simply showed the equity funds. There is another long list of funds for bond exposures. There is simply no need for a portfolio to be this complex. For comparison, Vanguard’s Target Retirement 2020 Fund (MUTF: VTWNX ) includes only five allocations and one of them is less than one percent. Volatility An investor may choose to use FFFDX in an employer sponsored account (if their employer has it on the approved list) while creating their own portfolio in separate accounts. Since I can’t predict what investors will choose to combine with the fund, I analyze it as being an entire portfolio. (click to enlarge) When we look at the volatility on FFFDX, it is dramatically lower than the volatility on the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ). That shouldn’t be surprising since the portfolio has some large bond positions. Over the last five years it has significantly underperformed SPY, but that should be expected given the much lower beta and volatility of the fund. Investors should expect this fund to retain dramatically more value in a bear market and to fall behind in a prolonged bull market. Despite that expectation, for having a beta of .56%, delivering less than half the gains of the S&P 500 is really sad. It isn’t like the portfolio simply has an enormous amount of cash sitting around. A target date fund should have a substantial allocation to treasury securities. As you might recall, treasury securities did fairly well. Over the last five years the iShares 20+ Year Treasury Bond ETF (NYSEARCA: TLT ) was up 36.4%. Want lower volatility with better annualized returns? Simply combine TLT and SPY as demonstrated in this hypothetical portfolio: (click to enlarge) This portfolio produces a lower level of annualized volatility and superior returns despite having only two tickers. SPY provided domestic equity and TLT provided long term treasury exposure. The reason to have a target date portfolio is so that it is automatically readjusted over time to reduce risk (at the cost of expected return). Opinions The first change I would want to make here is to see a lower expense ratio and a dramatically simplified portfolio of holdings. There is no need for a large complicated portfolio. To drive annualized volatility down while using Fidelity funds, I would favor using the Spartan ® Long-Term Treasury Bond Index Fund – Fidelity Advantage Class (MUTF: FLBAX ). The fund has a very high weighted average maturity (around 25 years), over 99% of the portfolio is in treasury securities (low credit risk), and an expense ratio of only .1%. That is a good solid mutual fund and using it in a target date portfolio fund with regular rebalancing allows investors to automatically take advantage of the negative correlation that long term treasuries have with the domestic equity market. Conclusion When an investor takes on an expense ratio that is even .3% higher and pays that ratio for 20 years, they are looking at losing 6% of the value of the portfolio without accounting for compounding. If investors account for the benefits of compounding and assume annual returns are positive, the potential value lost is even greater than 6%. FFFDX is an expensive option for investors looking for a simple “set it and forget it” retirement plan from their employer sponsored retirement accounts. The volatility of the fund is not a problem and the total exposures are not unreasonable. The problem comes down to two issues. One is that the fund has needlessly complicated the portfolio holdings and the other is that the expense ratio is simply too high when compared to similar products offered by competitors. There are some great funds offered by Fidelity and I have positions in a few of them. Unfortunately, this fund just falls short of the mark. Disclosure: I am/we are long FSTVX. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis. Scalper1 News
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