SKARBECK: More reforms sought for target-date funds

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.

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 [email protected]

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