Target date funds are coming under heavy scrutiny on Capitol Hill, with lawmakers and regulators working hand in hand to determine if these one-stop-shop retirement funds are in need of increased oversight — or perhaps even restrictions that would prevent them from investing too aggressively.
Target date funds are coming under heavy scrutiny on Capitol Hill, with lawmakers and regulators working hand in hand to determine if these one-stop-shop retirement funds are in need of increased oversight — or perhaps even restrictions that would prevent them from investing too aggressively.
Sen. Herb Kohl, D-Wis., chairman of the Senate Special Committee on Aging and leader of the target date probe, has enlisted the help of both the Department of Labor and the Securities and Exchange Commission in his review.
At the same time, sources said, he has been reaching out to many mutual fund companies to learn why seemingly similar target date funds have generated such a wide range of returns over the last year — with some funds for older individuals losing as much as 40% of their value.
"I share your heightened concerns that investors may hold these funds without in fact understanding the associated risks," SEC Chairman Mary Schapiro wrote in a recent letter to the senator, who first reached out to both the SEC and the Labor Department at the end of February.
TAG-TEAMING
Her sentiments were echoed by Labor Secretary Hilda Solis, who in a separate response to Mr. Kohl suggested that regulatory actions could result from the agencies' tag-team target date investigation.
"Given the variation in equity holdings among funds with the same targeted retirement date, participants may be unknowingly exposing their retirement savings to financial risks," she wrote. If that does indeed prove to be the case, the agencies "will determine what regulatory or other guidance is necessary to address the identified problems," Ms. Solis added.
Target date funds — which Boston-based Cerulli Associates Inc. recently predicted could gather up to $1 trillion in assets by 2012 — typically comprise a mix of equity and bond funds.
In theory, these funds are supposed to change their asset allocation gradually over time to favor more-conservative fixed-income vehicles as investors approach their retirement dates. This has made target date funds increasingly popular options in 401(k) plans, particularly after the Labor Department deemed them an appropriate default investment when workers are automatically enrolled in a 401(k).
Yet Mr. Kohl, the Labor Department and the SEC have now suggested that the actual asset allocations behind many target date funds aren't as conservative, or low-risk, as many investors anticipated.
"It's a valid and important point that they're making," said Phil Suess, principal and head of the defined contribution investment consulting practice at New York-based Mercer LLC.
"Everyone thinks all [target date] funds are the same," he said. "And they're not at all."
On average, 2010 target date funds — which should be among the most conservative because of their shorter investment horizon — lost 23.8% for the one-year period ended March 26, according to data from Chicago-based Morningstar. The Standard & Poor's 500 stock index, meanwhile, declined by 37%.
During this time, however, some funds experienced much more significant declines than others. The Oppenheimer Transition 2010 Fund, from OppenheimerFunds Inc. of New York, for instance, posted a 40.16% loss, making it the worst-performing retirement-stage target date fund tracked by Morningstar. (The top performer was Frankfurt, Germany-based DWS Investments' DWS Target 2010 Fund, which lost 6.22% for the one-year period.)
Such substantial losses will make asset allocation the clear bull's-eye in the target date probe. "At this point, a mutual fund firm can slap the label 'target date fund' on just about anything," Mr. Kohl wrote in an e-mail to InvestmentNews.
"We need a better definition of what the composition of target date funds should be at various stages," the senator wrote. "Right now, we don't have that."
That is sure to be unwelcome news to most target date fund managers. "Hopefully, it doesn't just prove to be an asset allocation witch hunt," said one target date fund executive, who asked not to be identified, as his firm was recently contacted by Mr. Kohl to learn more about the design and construction of its offerings.
"You're coming off of a year that was a once-in-a-century economic event," the official said. "You don't want to throw out the baby with the bath water just yet."
Officials from both the Labor Department and the SEC declined to comment on their review of target date funds.
It is unclear whether the review could lead to specific limitations on the equity allocations that target date funds are permitted to employ at certain points on their path to retirement dates.
Although placing caps on equity exposures "may seem to be a bit paternalistic," it may not necessarily be imprudent, said Jason Roberts, head of the Employee Retirement Income Security Act plan and in-vestment fiduciary practice at Los Angeles-based law firm Reish Luftman Reicher & Cohen.
While there was $152 billion invested in target date funds at the end of last year, according to Morningstar, most of these assets came through 401(k) plans, he said.
When it comes to 401(k) plan participants, "it's the DOL's job to be paternalistic," particularly when dealing with funds that the Labor Department has deemed suitable as default investment options for participants, Mr. Roberts added.
LABELS, AT LEAST
A more innocuous outcome, perhaps, would be for regulators to require target date fund providers to label their funds clearly as "conservative, moderate or aggressive," based on their levels of investment risk, said Gregory Ash, head of the ERISA litigation group at Spencer Fane Britt & Browne LLP, a law firm in Kansas City, Mo.
This would allow investors to have an immediately improved un-derstanding of a target date fund's expected performance, he said. Plus, it could also make it easier for employers — and their retirement plan advisers — to select the most appropriate target date funds for their 401(k) platforms.
"You don't ever want to be the plan sponsor or adviser that selects the bottom performer — especially if a target date fund is your default and you're automatically investing participants' assets in it," Mr. Ash said. "That could open you up to a whole new set of potential liabilities."
E-mail Mark Bruno at mbruno@investmentnews.com.
