Funds resist regulation of target date pensions

By Mariana Lemann for FT, July 6 2009

Fund managers are working hard to convince US regulators to keep their hands off target date funds, which have become widely used as default funds in retirement savings plans.

The idea of establishing regulatory guidelines for the asset allocation of target date funds surfaced following the losses suffered by investors in near-dated funds, particularly 2010 funds. These funds lost an average 24 per cent in 2008, and 4.7 per cent in the first quarter of 2009, according to Financial Research Corporation.

Investors’ dim hopes of recouping the losses before retirement, coupled with the fact that target date funds held more than $156.7bn (£96bn, €111bn) at the end of the first quarter, led the Department of Labor and the Securities and Exchange Commission to take a closer look at how these funds are designed, managed and marketed to investors.

The joint hearing, on June 18, was prompted by Senator Herb Kohl, who serves as chairman of the Special Committee on Aging. Mr Kohl in February sent letters to DOL secretary Hilda Solis and SEC chairman Mary Schapiro asking them to consider regulating target date funds. Under the Pension Protection Act of 2006, target date funds are one of three default investment options into which employers can automatically enrol participants.

Although several aspects of target date funds’ composition, mechanics and communication were discussed, the potential for government mandated asset allocation guidelines was a controversial focal point.

The majority of fund company representatives testifying said regulating target date funds would stifle innovation. “If the SEC puts something forward, we will of course take a look at it, but we’ve done a lot of thinking in this area and we just can’t come up with something that is any better than what we have right now,” says Karrie McMillan, general counsel for the Investment Company Institute, the national association of the US mutual fund industry, who testified before the SEC and the DOL. She argues that regulating these funds, a step the government has never taken before, could be dangerous.

Managers and consultants also argue that if glide paths were to be mandated, their ability to customise them would be compromised. (A glide path is the strategy by which a target date fund’s asset allocation shifts from aggressive to conservative over time.)

“The fund companies and the ICI essentially said ‘everything is fine, you, the government, stay out of our business’,” says Joe Nagengast, principal for Target Date Analytics, a provider of target date fund indices, who testified before the agencies.

“I think that is a disingenuous comment because the fund companies take all the authority for making the investment decisions in target date funds but have zero responsibility for the outcomes.”

Putnam Investments was a lone voice of dissension from the other asset managers at the hearings. In his testimony, Jeffrey Knight, managing director and head of global asset allocation, said the firm “would not oppose regulatory guidelines”.

Without guidelines, portfolio managers may be incentivised to diverge from a fund’s mandate, which translates into investors taking on more risk in their portfolios than they might have expected, says Jeffrey Carney, head of global marketing, products and retirement at Putnam.

Another hot topic of debate within the industry – target date fund names and what they mean to investors – also arose at the hearing.

Panellists appeared to agree there are funds that are managed to get participants “to” retirement, while others aim to manage their investments “through” retirement, although this distinction is not explicit in fund literature tailored to participants or plan sponsors.

“If you are a ‘through’ retirement fund, you think you have a mandate to manage that money until each participant dies,” Mr Nagengast says. “And so, as a result, compared to the ‘to’ fund you are much more aggressive at the target date, because . . . nothing happens at the target date.”

That distinction is not filtering through to plan participants, panellists said. Investors often make assumptions that are far removed from what target date funds can actually deliver, they said.

A recent survey shows that 61 per cent of respondents say target date funds make some type of promise. Over 60 per cent of employees say that investing in target date funds means they will be able to retire on the target date; 38 per cent think target date funds offer a guaranteed return; and 30 per cent think they can save less money and still meet their retirement goals if they invest in a target date fund, according to an online survey of 250 workers conducted by Behavior Research Associates.

Vanguard, T Rowe Price and Fidelity, asset managers that hold more than 76 per cent of target date fund assets, have endorsed recommendations from the ICI on the disclosure of the relevance of the target date used in a fund name, including what happens and what does not happen on the target date.

Following the joint hearing, Mr Kohl applauded the agencies’ efforts.

“The hearing clearly demonstrated that while target date funds are a great idea in theory, at this point there is far too much variance in the kinds of plans that carry the label,” he wrote in an e-mail to FTfm. “The need for these regulatory authorities to set a definitive standard for what can be called a target date fund is indisputable.”