By Sam Mamudi

After last year's heavy losses, the performance of target-date mutual funds has been heavily scrutinized and criticized. Now investors have a way to judge the 20-biggest lineups of these retirement-focused offerings.

Investment researcher Morningstar Inc. (MORN) introduced its target-date fund ratings Wednesday. Topping the list: Vanguard Group, while OppenheimerFunds landed at the bottom of the pile.

"Target-date funds have become very critical investments and we want to point out where the weaknesses are," said Laura Lutton, editorial director in Morningstar's mutual fund research group.

 
   Performance Gauge

The ratings will be of particular interest because target-date funds' long time horizons make it hard for investors to assess their performance - it's difficult to tell if a 2040 fund, for instance, has suffered a bad stretch relative to its goal of providing adequately for retirement.

"These are very complex offerings that haven't received a lot of scrutiny," Lutton added. "In some cases there are best practices we want to highlight and in others there is work do to."

The Morningstar ratings judge target-date fund lines - the total offerings from a single fund firm - in five areas: statistical and fundamental measures of a fund's management plus analysis of individual funds, their holdings and costs.

Lutton said the new system looks at entire fund lines because target-date funds are typically offered as whole line-ups in 401(k) plans.

As well as Vanguard, firms with industry-leading target-date lines include American Funds, American Century Investments and T. Rowe Price Group (TROW).

 
   Risk and Time

Morningstar found that target-date funds with long time horizons lost the most in 2008 - perhaps unsurprising given that they have the riskiest portfolios, which hold the most stocks. Funds dated 2031-2035, 2036-2040 and 2041-2045 lost 36.9%, 37.8% and 38.1% respectively last year.

"The poor returns of many target-date funds intended for investors close to or in retirement came as a greater surprise, however," said a Morningstar research note.

"We saw a lot of disparity [in risk and returns] the closer you get to the retirement date," added Lutton.

Oppenheimer Transition 2010 (OTTAX) lost 41.2% last year, while Vanguard Retirement 2010 (VTENX) was down 20.6%.

Lutton said Morningstar is "agnostic" about how risky funds choose to be, but that it's important for investors to know their funds' approach.

 
   Strict Criteria

In judging target-date funds, Morningstar has taken a page from the way it assesses typical mutual funds. Its fund management measures chime with the stewardship grades the researcher gives to most mutual funds.

"If this is an investment that you're going to hold for about 30 years, you need to know the type of manager you'll be with," Lutton said.

The analysis looks at the quality of the fund managers and also of the managers of the underlying funds, manager incentives - preferably geared towards long-term returns - and the strength of board oversight. It also considers a fund firm's corporate culture, the transparency of the target-date funds and whether the firm has had any issues with regulators.

Morningstar also considers the average price charged by a firm across its line of target-date funds.

For performance, Morningstar examines a fund line's risk-adjusted returns relative to other target-date funds. The research also looks at the quality of the underlying funds a target-date fund may hold - many target-date funds use a fund-of-fund structure.

Morningstar ranks the fund lines in five categories: top, above-average, average, below-average and bottom. Lutton said that a ratings system similar to the firm's well-known star rating may eventually be added.

Vanguard's funds received a top rating for fund managers and overall firm rating and price; it garnered an above-average rating for performance and an average rating for the quality of its portfolio.

Lutton noted that the Fidelity Advisor Freedom series of funds suffers in Morningstar's eyes because of its underlying holdings, with the funds investing in some of Fidelity's less stellar fund offerings.

"Fidelity has a lot of funds we like [but the target-date funds] invest in smaller funds with not very well established track records," she said.

The Fidelity lineup receives a 'below average' rating for their portfolio holdings.

Lutton speculated that this was because many of Fidelity's better performers are either closed to new investment or would have trouble dealing with the volume of cash pouring in through the target-date funds.

Fidelity defended its products. "Our [target-date funds] include some of the best-performing Fidelity funds," said Alexi Maravel, a spokesman for the Boston-based fund giant. He named Fidelity Growth Company Fund (FGCKX) and Fidelity Diversified International Fund (FDIVX) in particular.

Maravel also noted that Fidelity's 2050 target-date fund has beaten 93% of its Morningstar peers over the past three years.

OppenheimerFunds, meanwhile, called 2008 "an extraordinarily challenging year for the markets, and some investments did not meet our expectations" - particularly the firm's Core Bond Fund (OPIGX), a spokeswoman said in an email.

The spokeswoman added that OppenheimerFunds has taken steps to improve its target-date portfolios, including hiring a new fund-management team, appointing a chief-investment officer of fixed income, and hiring a senior risk officer.

-By Sam Mamudi; 415-439-6400; AskNewswires@dowjones.com