Target-date funds became the leading default investment option for auto-enrolled retirement plans for a reason: The simplicity of an age-appropriate, asset allocation strategy that grew more conservative as plan participants edged closer to retirement age.

It was a savings vehicle seemingly on auto-pilot that producers could recommend with confidence.

But since the economy went south, TDFs have been under siege, with a Government Accountability Office report released Feb. 23 noting wild disparities among funds with the same target date.

Three such indicators were equity allocations ranging from 35% to 65%, annualized returns in the largest such funds ranging from a 28% gain to a 31% loss between 2005 and 2009, and fund fees ranging from 19 to 171 basis points.

The report suggested that the Department of Labor provide guidance on TDF benchmarks and information about the impact of withdrawals or changing contributions, as well as long-term investment allocations and assumptions.

The GAO review of TDFs was requested in November 2009 by Sen. Herb Kohl, D-Wis., and Rep. George Miller, D-Calif., the senior Democrat on the House Education and the Workforce Committee, after the financial crisis triggered huge losses in retirement plans. But the DOL, which is expected to issue new disclosure rules this year, dismissed the GAO’s recommendations as too vague.

Missed opportunity?

The question now becomes, to what extent might additional regulatory requirements serve to help or hinder TDFs?

On one side of the argument is David Wray, president of the Profit Sharing/401(k) Council of America in Chicago, who believes the DOL was correct to reject the GAO recommendations for additional regulations for TDFs used as 401(k) automatic enrollment defaults.

“It is important that plan participant understand that target date funds are partially invested in equities and that there will be some level of principal volatility,” he explains, noting that both the DOL and Securities and Exchange Commission (SEC) are addressing this issue. “Any further regulatory intervention will stifle intervention in what is an evolving and improving investment program. The selection of any specific target date fund for a plan should left totally to the discretion of plan fiduciaries.”

But other industry observers say the GAO squandered an opportunity to make a meaningful difference. Joseph C. Nagengast, a principal at Target Date Analytics LLC in Marina del Rey, Calif., which created the BrightScope On Target Indexes, says that while the agency admirably identified fundamental difference between funds as arising from their objectives, it failed on a truth-in-labeling recommendation.

His point is that there’s an inherent deception in TDFs with dates in their names that are not linked to the landing point in their glide path. “Unfortunately, the DOL and SEC disclosure requirements will sanction that deception,” he cautions. One way to curtail any deception would be extending to TDFs the so-called fund-names rule known as SEC Rule 35d-1.

“If fund companies are so certain that extending a glide path 30 years beyond retirement is good for participants,” he says, “they can explain that to the participants and attempt to persuade them to make that choice rather than deceiving them into that position by mislabeling the funds.”

Nagengast also suggests the DOL require mutual fund companies that offer a TDF, not just investment advisers and banks, to accept fiduciary status under Section 3(38) of ERISA.

Their exemption was secured “on the basis that the fund companies had many investors outside of qualified plans, and therefore couldn’t be expected to extend ERISA fiduciary loyalty to non-ERISA clients,” he explains.

But he says TDFs were designed specifically for qualified plans, noting that "80% of their assets are still in those plans. Separate share classes can be created for non-ERISA investors. If the fund companies were held to account for their actions they might be a little more prudent in their glide path designs."

Bruce Shutan is a freelance writer based in Los Angeles.

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