Regulatory leaders are questioning whether changes need to be made to target-date funds after several 2010 funds reported huge losses last year, but mutual fund industry leaders say these concerns are overblown.
Industry leaders agree that target-date funds, also known as lifecycle funds, should become increasingly conservative as they approach their target date, but disagree on how conservative the funds should be, and whether or not a glidepath should continue past the target date. Many investors are not aware of this discrepancy and might incorrectly assume their fund has a much different asset allocation than it really does.
An investor in a 2010 target-date fund might expect the fund to be very conservative, but many of the funds are designed to maintain a heavy exposure to equities well past the retirement date. These riskier glidepaths obviously backfired in 2008.
"There is a misperception that if I have two target-date funds with the same name, they have the same equity exposures," said Marie Swartzwelder, vice president of investment strategy at Prudential Retirement. "We need to find a way to get glidepaths to reflect not only the participant's age but their risk tolerance, but we don't want glidepaths legislated to us."
"We strongly oppose any efforts to regulate the glidepaths or other aspects of the investment design or construction of target-date funds," said John Ameriks, a principal with The Vanguard Group.
At a hearing of the Securities and Exchange Commission and the Department of Labor on target-date funds earlier this month, regulatory leaders questioned industry experts on the role the funds play in retirement accounts, the funds' performance during the last year and what changes can be made to the funds, if any, to better serve investors.
"Target-date funds provide an efficient way for an investor to invest in a mix of asset classes through a single fund that both rebalances its asset allocation periodically and becomes more conservative over time," Karrie McMillan, general counsel for the Investment Company Institute, said at the hearing. "Target-date fund investors avoid extreme asset allocations that we often observe in retirement accounts, such as the 25-year-old holding all cash or the 60-year-old fully invested in equity funds. Target-date funds follow professionally designed asset allocation models to eliminate such extremes."
Industry leaders blame last year's disastrous market for the terrible performance of these products in 2008, and they note that diversification doesn't matter when both stocks and bonds drop.
"The 'set-it-and-forget-it' approach of target-date funds can be very appealing to investors," SEC Chairman Mary Schapiro said during the hearing. "Target-date funds were expected to make investing easier for the typical American and avoid the need for investors to constantly monitor market movements and realign personal investment allocations."
"The beauty of a glidepath is that it's easy for investors to understand," said Richard Whitney, director of asset allocation at the T. Rowe Price Group. "Risk tolerance declines over time, so naturally people expect their portfolio to adapt over time."
Inflation and cost-of-living expenses can slowly erode retirement savings over time, and with an increasing number of people living 30 years or longer in retirement, financial professionals stress that investors will have to maintain some form of exposure to equities throughout their retirement.
But how much exposure?
The 31 target-date funds with 2010 in their names had equity allocations ranging from between 21% to 79% of their assets, Schapiro said.
"Perhaps even more surprising were their widely varying performance results," she said. "Returns of 2010 target-date funds in 2008 ranged from minus 3.6% to minus 41%. These varying results should cause all of us to pause and consider whether regulatory changes, industry reforms or other revisions are needed with respect to target-date funds."
"The name of each fund must bear some relationship to the way fund is managed," said Joseph Nagengast, a principal at Target Date Analytics, during testimony before the SEC/DOL panel. "If a fund labeled 2010 is really targeted to land at 2040, it should be relabeled as a 2040 fund."
Schapiro said she has asked the SEC staff to examine "whether the use of a particular target date in a fund's name is materially deceptive or misleading and should be prohibited."
Some regulators and investors are furious that some target-date funds could be so off target.
"Put yourself in the place of a person who is retiring in seven months who thought he was invested in a safe target-date 2010 fund with low volatility and then lost 41% last year," said Marilyn Dimitroff, chair of the Certified Financial Planner Board of Standards.
The headline grabber was the Oppenheimer Transition 2010 Fund, which lost 41% in 2008, but with $20 million in assets under management, the fund had just a tiny sliver of total target-date assets of $187 billion.
The top four firms-Fidelity Investments, Vanguard, T. Rowe Price and Principal Financial-control about $161 billion of the total target-date fund assets, or nearly 85%, according to Morningstar. The average loss among all target-date funds in 2008 was 25%, far better than the average market loss of 37%.
The fact that most 2010 target-date funds beat the 2008 market has not been widely reported, nor has the fact that most of these funds are already on the way to recovery.
Mutual fund industry advocates have always encouraged industry self regulation, and they are hoping they can persuade regulators to cool down and make no changes.
"Target-date mutual funds currently do a good job of disclosing the key information that fund investors want and need," McMillan said. "However, we think sponsors of target-date funds, whether mutual funds or other products, can and should do more to ensure better investor understanding."
Investors are not forced to stay in any particular fund, and even if they were defaulted into a certain fund, "the investor can always make an affirmative election to invest in other investment options offered by his or her plan, including a target-date fund with a different target date, holding a larger or smaller percentage of equities," according to the ICI's frequently asked questions about the funds.
Target-date funds have been around for years and the diversity of glidepaths is nothing new. Tools like JPMorgan Asset Management's Target Date Navigator or UAT Inc.'s Unified Compliance and Control System can help investors and plan sponsors to find out how certain funds compare with others of a like name.
This "buyer-beware" approach of making sure that investors are given all the tools necessary to identify and understand the risks in these products may protect fund companies from litigation, but regardless of the amount of disclosure regulated or voluntary, the reality is that a large number of investors will probably stay in whatever fund they were automatically defaulted into.
Markets and investors have short memories, and after a few years of double-digit returns, many investors at or near retirement will find equities too good to pass up and look for target-date funds that can give them the returns they seek.
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