SKARBECK: More reforms sought for target-date funds

June 29, 2009

Target-date mutual funds, a popular investment vehicle in 401(k) plans and college savings plans, have recently come under scrutiny by Congress and regulators.

Also known as a life-cycle fund, a target-date fund is typically a packaged blend of stock and bond mutual funds, which gradually shift the asset allocation over a "glide path" toward a conservative investment posture as the target date approaches.

The spotlight has been turned on target-date funds because countless investors are in an uproar over the recent poor performance of funds nearing their target date.

According to the Securities and Exchange Commission, the average loss for mutual funds with a target date of 2010 was almost 25 percent in 2008. In particular, older employees with retirement just around the corner are complaining they were misled by these mutual funds. Many were assuming their market risk was minimal as their retirement date approached.

And thus, a glaring source of confusion is that the actual name of a target-date fund can be misleading. Investors might think a fund with a target date of 2010 implies some sort of promised result at that date, but that's not the case.

In fact, most target funds are designed to carry an investor through his or her entire retirement years, well past an actual retirement/target date. So, for example, while a 2010 target-date fund would have shifted more money out of stocks and into bonds over its glide path, it most likely still has a sizable allocation in stocks in an effort to provide the portfolio growth a retiree will need over his or her life span.

In other words, a 2010 target-date fund invests under the pretext that you will retire in 2010 and remain invested in the fund the rest of your life.

According to one congressman who studied the issue, the stock component in 2010 target-date funds varied from 24 percent to 68 percent. And, likewise, the investment losses for 2010 target-date funds varied from 3.6 percent to 41 percent in 2008.

The mutual fund industry is concerned that regulators could move to dictate controls on the asset-allocation process of target-date funds. For instance, requiring that a 2010 fund may allocate only 20 percent of its assets to stocks would bring about some standardization and allow investors an easier way to compare competing target-date funds.

Instead, the Investment Company Institute (the mutual fund industry's association) and venerable fund researcher Morningstar both believe the solution is better disclosure in marketing materials. That includes making clear that the target date means the approximate date an employee stops making new contributions to the fund.

Another suggestion is that target-date funds should provide a more detailed breakdown of how the asset allocation changes over the glide path. Better disclosure of the risks and fees in these funds is also suggested.

Ironically, the recent poor performance in some target-date funds was due to disastrous bond-fund allocations. Some target funds held fixed-income mutual funds that were invested in subprime bonds, which experienced large losses.

And finally, while many investors in near-term target-date funds were blindsided in this market decline, two other key investing principles that purport to diminish risk also failed to protect target-date funds-asset allocation and diversification. All this just confirms that there were few places for investors to hide.•

Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money management firm. His column appears every other week. Views expressed are his own. He can be reached at 818-7827 or ken@aldebarancapital.com.

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