Target-Date Glidepaths Set Course for Start of Retirement or Beyond
Regulators Grapple With Various Goals
September 7, 2009
When like-named target-date funds experienced a wide range of investment returns in 2008, regulators at the Securities and Exchange Commission and the Department of Labor took notice.
In addition to discovering a wide discrepancy in asset allocation techniques and performance, regulators discovered two fundamentally different glidepath strategies: one that gradually reduces an investor's equity exposure to a very conservative level by the time they reach the target date, and a strategy that maintains significant equity exposure well beyond the target date.
Most retirement planners agree that retirees should maintain some equity exposure during retirement in order to keep up with inflation and a retirement that could last three decades or longer, but what this level of exposure should be-and whether or not the government should set some parameters-is being widely debated.
A study by the SEC found that 31 target-date funds with 2010 in their names had equity allocations ranging from between 21% to 79% of their assets. The 2010 fund with a 79% exposure to equities was an exception to the norm and obviously backfired during the disastrous market crash in late 2008, losing 41%.
Target-date funds are intended to help unsophisticated investors manage their changing asset allocation needs over time. Most investors assume the funds will grow more conservative and protect their savings as they approach the target retirement date.
"The big issue is what the participant believes these funds will do," said Luis Fleites, vice president and director of retirement markets at Financial Research Corp. in Boston.
"Many participants were under the impression that they were shifting to a very conservative, lower equity and lower risk fund, in order to protect their investments," Fleites said. "Whichever direction a target-date fund takes, there needs to be clear communication with the participant."
Andrew Donohue, director of the SEC's Division of Investment Management, told MME that a careful review of these target-date funds revealed that they all generally did what they told investors they were going to do and their disclosure to investors was pretty clear. The challenge then, is how to get investors to read the fund prospectus information and stop assuming that all target-date funds are equal.
"The fund's name doesn't tell you everything you need to know," said Mary Podesta, senior counsel for pension regulations at the Investment Company Institute. "In all of these funds, experts assume the participant will stop making contributions and retire at that date."
The ICI believes there is no "right" glidepath for target-date funds, nor is there a "one-size-fits-all" target-date fund for all plans. In line with industry sentiment, the ICI is adamant that the decision on how these funds should be constructed and used should be left to investment professionals and plan fiduciaries.
"We share the regulators' interest in making it easier for investors to understand target-date funds, but we strongly believe that the glidepath ought to be left up to the experts," Podesta said. "Using the retirement date in the name is the right date to use. It's an easy date for investors to remember."
The ICI does not think the SEC should change how target-date funds are named, and argues that changing or regulating the fund names would not enhance investor understanding and could lead to more confusion.
ICI President and CEO Paul Schott Stevens said it is the responsibility of employers to understand the services and investment options in their 401(k) plans, as well as the costs that these plans will incur. Furthermore, he said employees need to receive clear, concise information about their investment choices and the fees they pay, as well as have access to investment advice.
"A significant and growing number of participants remain in their 401(k) plan after retirement and a large percentage of participants tend to 'do nothing,'" said Tom Idzorek, the chief investment officer and director of research at Ibbotson Associates, a subsidiary of Morningstar, Inc. "Thus, the strategy should continue to evolve throughout retirement for those that remain in the funds. We should note that it is often beneficial to remain in a 401(k) plan after retirement, given that retail rollover accounts often come with higher fees."
Target-date funds that are intended to manage a participant's assets past retirement can only achieve this goal if retirees stay in these accounts.
Numerous studies on investment behavior have shown that a large number of participants will follow the default option, rather than make an active selection. If a retirement plan automatically rolls over new retirees into a post-retirement target-date fund or even the same target-date fund, these funds will achieve their goal, but many plans automatically default new retirees into money market funds or kick them out of the plan altogether.
If a participant is required to roll over their assets upon retirement, they probably won't roll over into another target-date fund, Fleites said.
"Rollovers are so commonplace in the DC world that the money is not staying put," he said. "My guess is that if they're retired, they're probably not going to look for a target-date fund to roll over into. They will most likely go into the default money market fund, and then potentially reallocate to something like annuities."
Target-date providers include mutual funds, collective investment trusts and separate accounts. If these manufacturers believe they have an appropriate glidepath, they won't want it to be labeled as aggressive, especially if they are trying to get it approved as a qualified default, Fleites said.
"The scrutiny of target-date funds after 2008 was probably warranted," said John Sturiale, director of the Schwab Retirement Investment Services Group. "We popped the hood on our funds after 2008, reassessed the variables and ended up not making one change. We tested our glidepath and we believe it's sustainable."
Podesta said any regulatory response or changes should apply to all target-date funds and target-date providers, not just mutual funds.
"The disclosure rules ought to be the same," she said.
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