Regulators Urged to Review Target-Date Funds

This article was originally published by Financial Planning on Thursday, June 18, 2009.

By Katherine Reynolds Lewis

Government regulators should standardize the naming of target-date funds and require mutual fund companies to assume a fiduciary duty in providing such funds to retirement plans, witnesses told a joint hearing of the Labor Department and the Securities and Exchange Commission.

"We believe there should be a consistent standard, although we don't believe there should be a mandate on investment options," said Mark Wayne, speaking on behalf of the National Association of Independent Retirement Plan Advisors. "Fund managers should explain in plain English what the landing point will be."

The plummeting market of 2008 cost investors dearly—up to 30 percent drops in some funds targeted to 2010—and has focused attention on target-date funds, since they are often the default choice in employer retirement plans.

The SEC is concerned that investors may be misunderstanding the purpose and capabilities of target-date funds, which affect a large number of retail investors, SEC Chairperson Mary Schapiro said.

A March survey of workers who were presented target-date fund marketing materials found that 70 percent perceived a promise being made and over 60 percent believed such an investment would guarantee they'd be able to retire on the target date, said Jodi DiCenzo of Behavioral Research Associates.

"How can we drive the message home that how much you save is of critical importance?" DiCenzo said. "Until we can answer these questions, American workers are investing in false hope."


Representatives of the mutual fund industry recommended that any confusion be addressed through enhanced disclosure, not new rules.

"We do see gaps in the public understanding of target-date funds generally," said Karrie McMillan, general counsel to the Investment Company Institute. "We are firmly convinced that investor understanding of target-date funds should be improved through disclosure and education."

An ICI working group considered the possibility of changing the current convention of linking a target-date fund's name to the expected date of retirement, and concluded that it could increase investor confusion without improving the situation, McMillan said.

"We strongly oppose any effort to regulate the glide path or any investment design," said John Ameriks of Vanguard Group. "Target-date investing is one of the most significant and promising innovations in years."

Nevertheless, several witnesses criticized the many target-date funds whose glide path continues to reduce its exposure to equities after the retirement date.

"No credible rationale has ever been proffered for using a glide path in the retirement phase," said Joseph Nagengast, principal at Target Date Analytics, whose 2010 index lost only 5 percent in 2008. "These excessive losses weren't necessary."

The Labor Department should develop a monitoring tool to help fiduciaries evaluate target-date funds with regard to asset classes, allocation, the number and quality of underlying funds, glide paths, costs and fees, said David Certner, legislative counsel for AARP.

"The older population tends to be more risk-averse," Certner said. "Individuals prefer security over risk-related gains they could have by overwhelming numbers. I think they value security much more than they value potential upside returns."

A glide path that is weighted heavily toward equities will generate higher fees for the fund manager, noted Michael Case Smith, a senior vice president at Avatar Associates.

"I do not think there is any conflict there at all," said Ann Lester, senior portfolio manager for JP Morgan Asset Management. "The very clear way to avoid any potential conflict of interest is to just state what your fee is irrespective of what the underlying fund choices will be."

Also, it's a conflict of interest for portfolio managers to invest exclusively in funds from their own company, as 70 percent of target-date funds do, said Jessica R. Flores, managing partner at consulting firm Fiduciary Compliance Center.

"I've yet to find an asset complex that is stellar in all categories," Flores said. "You just can't be great at everything."

Lester noted that how much people save is the greatest factor in their retirement planning success, not the specific investment allocations. An analysis comparing the 2010 glide path to a money market fund found that, over the last 20 years, the target-date fund would have double the assets of the money market fund—even taking into account the 2008 losses, she said.

Although some witnesses testified that mutual fund companies should be fiduciaries, today that responsibility is borne by plan sponsors. Almost 95 percent of the 401(k) plans in America had assets of $10 million or less, said Ian Kopelman, of the Profit Sharing/401(k) Council of America.

"The application of particular fiduciary standards to them must be effective but reasonable," Kopelman said.