Disclosure A Thorny Issue For Target-Date Funds

By Cyril Tuohy InsuranceNewsNet

By Cyril Tuohy

For such an elegantly simple investment approach to retirement, the target-date mutual fund sure has plenty of complications and approaches associated with how to fairly and accurately disclose its investment risks.

Target-date funds, which have become more popular with retirement investors, rebalance portfolios in accordance with the approximate date an employee plans to retire.

A worker who plans to say goodbye to the working world in 2050, more than 35 years from now, would have his or her assets weighted heavily toward stocks, or toward growth of the principal. The closer the employee approaches 2050 the more assets are shifted out of stocks and into bonds, so that by 2050 the portfolio is heavily weighted toward income.

That’s the easy part. The hard part is how or what to disclose to retirement investors about what they need to know regarding target-date funds (TDFs).

Retirement plan advisors, sensitive to the fiduciary liability that comes with managing a retirement plan on behalf of employers, say regulators need to make it absolutely clear that target-date funds do not guarantee investment options, nor even a successful retirement by the indicated date.

“TDF manufacturers and managers make a number of informed assumptions when constructing their TDF portfolio, and their assumptions for the ‘average’ TDF investor may or may not reflect an investor’s own circumstances,” said the National Association of Plan Advisors in written comments delivered to the U.S. Department of Labor (DOL) over the summer.

What to disclose in target-date fund plan documents with regard to asset allocation, how assets change over time, and assumptions about withdrawal intentions following the target date has been under discussion at the DOL for the last four years.

Earlier this year, the DOL sought a new round of disclosure comments after the Securities and Exchange Commission (SEC) Investor Advisory Committee recommended that the commission develop a “glide path” illustration to graph the change in asset mix in the fund leading up to and moving beyond the employee’s year of retirement.

DOL and SEC officials want to make sure target-date fund rules developed by the two regulatory bodies mirror one another closely to minimize confusion.

While plan advisors are concerned with fiduciary liabilities around disclosures, investment managers say too little leeway will harm investors.

Manning & Napier, an investment management firm headquartered in Fairport, N.Y., said target-date fund disclosures should be tailored to ”either the plan fiduciary or a participant audience as each has different decisions to make.”

Glide path illustrations based on standardized measures of risk, said Jeffrey S. Coons, president and co-director of research for Manning & Napier, do not allow enough flexibility for plan fiduciaries “to make decisions in the best interest of the plan participants.”

Target-date funds are the investment industry’s equivalent of the military’s “fire and forget” weapon. All a worker has to do is pick the fund with a matching retirement date and forget about the investment for the next 30, 20 or 10 years, or however long the employee plans to remain at work.

It’s a simple idea, and one that some companies use as a default strategy to get employees started with their retirement savings.

Ever since the Pension Protection Act of 2006 and DOL rules surrounding Qualified Default Investment Alternatives and employer liability protections, the growth of target-date investment funds has been widespread.

By the end of last year, target-date funds had amassed $618 billion, according to data supplied by the Investment Company Institute, a mutual fund trade group. Target-date funds are credited with improving retirement plan participation rates.

In fact, the idea proffered by target-date funds is so simple that it has attracted passive investors, exactly the kind of investor who does not read much in the way of fine print and disclosure in any kind of retirement fund document.

“Indeed, providing too much information can be as unhelpful as providing insufficient or inadequate information,” said David Certner, legislative counsel and legislative policy director for government affairs at AARP.

Assuming that workers and junior level managers who invest in target-date funds actually understand investment concepts would be a mistake, AARP said, citing studies that reveal significant levels of financial illiteracy among swaths of the U.S. population.

AARP, which represents nearly 38 million Americans age 50 and older, prefers a tiered disclosure model providing basic information to all plan participants, but offering more detailed disclosure to participants who are interested.

“By using tiered disclosures, participants will receive the information they absolutely should have, but have the opportunity to obtain more substantial and detailed information if they desire,” Certner said in written comments to the DOL.

There are 541 target-date funds in the United States, according to an Oct. 1 article posted on Bankrate.com, citing Morningstar data.

Cyril Tuohy is a writer based in Pennsylvania. He has covered the financial services industry for more than 15 years. Cyril may be reached at [email protected].

Cyril Tuohy is a writer based in Pennsylvania. He has covered the financial services industry for more than 15 years. He can be reached at [email protected].