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Changes on the Way for Target Date Funds?

Regulators are eyeing the popular retirement plan options, which recorded surprisingly poor results last year.
Kate O'Sullivan, CFO.com | US
June 24, 2009

For a while now, target date funds have seemed like a good option for retirement plan investors, many of whom don't want to sort through dozens of funds and don't know how to determine the right mix of investments to suit their retirement needs or their risk tolerance. Instead, plan participants could simply choose a fund based upon their retirement date, and the actively managed funds would shift over time to provide an appropriate asset mix. For investors who didn't want to spend a lot of time monitoring and researching their holdings, they were like a simple solution.

So it's no wonder 401(k) plan money has poured into the funds since their arrival in the market nearly two decades ago. And in 2006, when the Department of Labor deemed them a suitable automatic enrollment default option, participation accelerated.

Now, however, the plans are under scrutiny, with the Department of Labor and the Securities and Exchange Commission hosting a joint, all-day hearing featuring dozens of investment advisors, fund representatives, and industry analysts last week to determine whether target date funds require increased regulation or disclosure.

The dramatic growth in assets in the category-which now boasts some $182 billion in retirement savings-as well as their widely varied results in last year's brutal market, has raised a red flag for regulators, including SEC chief Mary Schapiro, who questions whether the funds' very names offer a misleading promise. Research by Behavioral Research Associates presented at the Washington hearing found that some investors thought that the fund's name implied a promised retirement date, or a date when the savings would be converted to cash. But the performance of funds like Oppenheimer Transition 2010, which at a 41% loss last year was the group's worst performer-suggests that future results might not be money good.

"Because they're used as a default and because of the tremendous growth thus far and the growth trajectory that people are predicting for target date funds, it's easy to see why there's been a lot of focus on them," says Chris Lyon, a partner with Rocaton Advisors, an investment consulting firm based in Norwalk, Connecticut. "They're also designed to solve [the problem of asset allocation], which last year by some measures they didn't solve very well." Instead, the 31 funds with a 2010 target date lost an average of almost 25%, with losses ranging from 4% to Oppenheimer's 41%.

"Among the lessons learned last year is that not all target date funds are the same," says Lyon. "The range of performance of these funds was wide enough to drive a truck through." Asset mix also differed dramatically between funds, with some 2010 funds holding 79% in equities while others held just 21%. There was some discussion at the hearing of establishing guidelines for the funds' asset allocation based on their target dates, an idea that Lyon says he hopes would still allow plan sponsors enough flexibility to choose the right plan for their employees-some of whom have pensions and other retirement assets-and would take into account the rapid change and growth in the number of options in the target date fund marketplace.

One new option that some plans are beginning to offer is a target date fund with insurance protection built in. The funds are more expensive, and their value still fluctuates with the market, but in exchange for the higher price tag investors receive a certain level of guaranteed retirement income. Should an employee's savings be wiped out due to a market meltdown just before retirement, for example, the insurance would kick in to provide the annuity income.

The short-term focus, however, will likely be on increased communication and education about how the funds work and increased disclosure of funds' holdings and strategies. "I don't think anyone's asking how to get rid of them, but people are talking more about how to help people understand them," says Pamela Hess, director of retirement research at Hewitt Associates. The funds are "still a great part of defined-contribution plans," especially for younger investors, she adds.

Lyon agrees. "If it's really the case that there's a misperception by participants that a 2010 fund is going to be in cash by 2010, then maybe we need to communicate differently. We would welcome any efforts to improve communications." Still, he says, many plan sponsors already try to reach employees and teach them about their retirement options. "In some cases, it doesn't matter how good your communications are. Many participants just don't read the stuff," he says.

The SEC and the DOL are continuing to study the funds and are accepting comments for 30 days. As they wait for potential new guidance, finance executives should be sure they have thoroughly documented their retirement plans' investment policy, their fund selection criteria, and their monitoring procedures, says Hess. "Make sure you understand the [funds'] methodology. Don't be afraid to change them," she says. "And look at multiple products." As investors clearly learned last year, they aren't as similar-or as simple-as they look.




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