Target date funds seen as a question of how rather than if

Target date funds are ripe for regulation — a conclusion made abundantly clear at a joint Department of Labor and Securities and Exchange Commission hearing this month dissecting these popular retirement funds. But exactly how regulators will attempt to rein them in is still an open question, according to experts and others who testified. “At its most basic level, there was a consensus that there needs to be an alignment of a target date fund's characteristics with the expectations of individual investors,” said Marilyn Capelli Dimitroff, chairwoman of the Washington-based Certified Financial Planner Board of Standards Inc., who offered testimony at the June 18 joint hearing. “There are a number of different ways of getting there through regulations, however,” said Ms. Capelli Dimitroff, who also is president of Capelli Financial Services Inc. in Bloomfield Hills, Mich. “And some ideas are more aggressive than others.” On one extreme end of the spectrum, there have been calls to regulate the asset allocation of target date funds, which invest across multiple asset classes and automatically dial down their equity exposure as investors approach an anticipated retirement date. Yet a more modest — and perhaps more likely — approach to implementing any new regulations would be to require asset managers that provide target date funds to disclose information more clearly about their funds' holdings, as well as their funds' specific risk characteristics. “In my gut, that's what I think the end result of these investigations and hearings will be,” said Rod Bare, director of asset allocation at Chicago-based Morningstar Inc., who was an expert witness at the hearing. “Any new regulations imposed on target date funds more than likely will be moderate.” That sentiment was echoed by another expert witness, Joseph Nagengast, a principal at Target Date Analytics LLC in Marina del Rey, Calif. “I don't think you'll have tough, hard-line, punitive regulations put in place that will tell mutual fund companies how they can and can't invest,” he said following the hearing. “But we need more truth in labeling.” For months, the Labor Department and the SEC have been zeroing in on target date offerings to determine why funds that are seemingly similar — at least on the surface — have recently produced a wide range of returns. Specifically, 2010 target date funds have received the most scrutiny from regulators and lawmakers, as these funds — which are designed for people who expect to retire around next year — theoretically are supposed to be the most conservative. “But the reality of target date funds was quite surprising to many investors,” SEC Chairman Mary Schapiro said during the hearing, noting that returns of 2010 funds last year varied from -3.6% to -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.” Several witnesses testified that the expanse of target date returns was a direct result of their widely differing asset allocations and “glide paths” — the specific course that a target date fund takes when winding down its equity allocation as an investor ages. As a result, more-aggressive funds with larger allocations to equity markets last year suffered greater losses than many investors anticipated. That has prompted some, such as Ms. Capelli Dimitroff, to suggest that the Labor Department and the SEC work hand in hand to establish guidelines for target date funds' asset allocations. “The date in a target date fund's name has to mean something to an investor,” she said. “We need to at least determine an acceptable range for a fund's asset allocation based on the fund's actual target retirement date.” Such an approach, however, drew the ire of officials in the mutual fund industry who also testified at the hearings. The Investment Company Institute does not “believe the agencies should seek to regulate the asset allocations of target date funds,” Karrie McMillan, the Washington-based association's general counsel, testified at the hearing. “In the 70-year history of mutual fund regulation, the government has never regulated the investment choices of mutual funds — nor should it now,” she said. E-mail Mark Bruno at mbruno@investmentnews.com.