Derivatives are financial instruments used to hedge risks or for speculation. They're derived from stocks, bonds, loans, currencies and commodities, or linked to specific events like changes in the weather or interest rates.
"While the hedges do cost something in terms of putting them into the portfolio, they have the potential to not only pay for themselves but they can and have been a source of out- performance at least historically," Miller, who's also a managing director at the firm, said.
Pimco's target-date fund for those retiring around 2020 returned about 2 percent with dividends reinvested last year. The firm started selling its target-date funds about four years ago because of their increased use by 401(k) plans, Miller said.
Target-date funds generally are designed to build capital by holding mostly stocks when an employee is younger, and shift to more conservative assets such as bonds as retirement approaches and the need for steady income increases. The federal government endorsed the funds in the Pension Protection Act of 2006, leading employers to favor them when automatically enrolling workers in 401(k) plans, and triggering an influx of money and companies that sell them.
'Tremendous Discrepancy'
The majority, or 53 percent, of plan sponsors that automatically enroll participants in 401(k)s use target-date funds as the default investment, according to a 2011 report by the Plan Sponsor Council of America, a Chicago-based trade group. There are more than 40 target-date mutual fund families employers may choose from and some sellers also offer them in collective trusts or customized versions, said Jeremy Stempien, director of investments for the retirement solutions group at Morningstar Investment Management.
"We can see tremendous discrepancy, tremendous differences among asset managers," said Harvard's Pozen, who's also a senior fellow at the Brookings Institution. "I don't think most people understand what they're getting."
Fidelity, Vanguard and T. Rowe Price Group Inc. controlled about 75 percent of the target-date assets in 2011, according to Morningstar. The average fee for a target-date mutual fund last year was about 1.1 percent, according to Morningstar, which included all share classes and retirement years such as the 2030 or 2040 funds.
Fees for the funds at Pimco and Invesco averaged about 1.2 percent. Vanguard, which mainly uses three broad-market index funds in its series, had the lowest expenses at about 19 basis points, or 84 percent less than the more expensive funds. A basis point is 0.01 percentage point.
Vanguard reported yesterday that in 2011 about 64 percent of new enrollees in 401(k) plans administered by the company invested solely in a target-date fund. The Valley Forge, Pennsylvania-based firm managed about $100 billion in the funds as of Feb. 29, according to spokeswoman Linda Wolohan.