Increasingly popular target date funds may be missing the mark because they are too narrowly constructed and make incorrect assumptions about participant behavior, according to industry insiders and new research.
CHICAGO — Increasingly popular target date funds may be missing the mark because they are too narrowly constructed and make incorrect assumptions about participant behavior, according to industry insiders and new research.
Critics say that the funds’ shortcomings could leave investors with far less money in retirement than envisioned.
A white paper released recently by JPMorgan Chase & Co. — “Insights: Ready! Fire! Aim?” — says that managers of target date funds may not be accounting properly for participant withdrawals, inadequate contributions and account loans. More important, the report’s authors say that asset mixes are too heavily weighted in favor of equities and underweighted in non-traditional assets such as real estate, emerging-markets debt and high-yield bonds.
The fact that many funds have shied away from any alternative funds poses a problem, said Tom Modestino, a senior analyst with Boston-based Cerulli Associates Inc.
“If you’re just looking at large-cap, mid-cap, domestic and international funds, you’re often ignoring other good funds, like hedge and commodities,” he said.
Investment in target date funds has soared, according to analysis from Cerulli Associates. In 2003, assets of these funds totaled $25 billion; today they stand at $126 billion, up from $115 billion at the end of 2006.
Observers, including those at JPMorgan, project that target date funds will become the No. 1 default option in 401(k) plans. But as these funds grow in popularity, advisers worry they’ll fall short of meeting their intended goals.
Joseph Masterson, senior vice president of Purchase, N.Y.-based Diversified Investment Advisors Inc., feels that target date funds provide too much equity exposure in retirement, which could cause devastating results to participants.
“I think a good number of end-date funds provide equity exposure in retirement that is well beyond the risk level that people assume they should be taking in retirement,” said Mr. Masterson, who believes that advisers should offer insight to plan sponsors about this problem.
Upping exposure
A number of fund managers, including The Vanguard Group Inc. of Malvern, Pa., and Boston-based Fidelity Investments, recently have increased their equity allocations in target date funds, said Lynette DeWitt, associate director of retail investment markets with Boston-based Financial Research Corp., a financial services consulting firm.
New York-based TIAA-CREF and Boston-based State Street Global Advisors Inc., the money management arm of State Street Corp., both said last week they are increasing equity exposure to their target date funds.
Ms. DeWitt also said that Baltimore-based T. Rowe Price Group Inc., Boston-based John Hancock Financial Services Inc. and New York-based AllianceBernstein Holding LP traditionally have had high levels of equity exposure in their target date funds.
“Generally, the market consensus is that equity exposure is a good thing,” Ms. DeWitt said.
But many target date funds have too much equity exposure, and that can harm participants, said Joe Nagengast, a principal in Turnstone Advisory Group LLC, a registered investment adviser in Marina del Rey, Calif., who believes that fund managers should base equity-level decisions on their effect on investors’ lives.
“When you talk about standard deviation, no one knows what that means,” he said. “We’re talking about people outliving their assets. You have to bring it back to reality.”
Those who favor higher equity exposure in target date funds believe that they are the true conservatives.
“If you’re underexposed, you’ll end up not having saved enough in retirement; your withdrawal rates will have to come down, and your money will have to last much longer,” said Dave Liebrock at Boston-based Fidelity Investments Institutional Services Co. Inc. Fidelity Investments’ target date funds invest in commodities,
leveraged loans and other non-
traditional investments.
Unfortunately, many plan sponsors choose target date funds without fully analyzing them or completely understanding a fund’s goal, said Anne Lester, a senior portfolio manager in JPMorgan’s global multiasset group and author of its white paper.
“A great role for a financial adviser is to help the plan sponsor understand a fund’s investment process,” she said.
“One of our big concerns is that plan sponsors take these vendors as a given and don’t do the evaluation, which can pose a lot of risk,” said Don Stone, an adviser with Plan Sponsor Advisors LLC in Chicago, who spends considerable time with plan sponsors helping to ensure that they understand the differences among target date funds.
Even if target date funds are not perfect, they provide a viable solution to vast numbers of people, said Ellen Rinaldi, who leads the investment counseling and research group at Vanguard.
“We believe there should be a shift out of equities over time, because bond exposure helps support income,” she said. “Target date funds strike a chord and fill a need.”
