From the August 2009 issue of Investment Advisor • Subscribe!

August 1, 2009

Retirement Planning: What's Next For Target Date Funds?

Debate focuses on "to" and "through" funds

What should become of target date funds? These are the so-called set-it-and-forget-it funds that are gaining in popularity, particularly since the Pension and Protection Act designated them as Qualified Default Investment Alternatives (QDIAs) for defined contribution plans. But the global financial crisis has shown that target date funds have shortcomings: the typical 2010 target date fund lost more than 20% in 2008.

A joint hearing held by the Securities and Exchange Commission (SEC) and Department of Labor (DOL) in mid June explored what sorts of changes target date funds may need to undergo. Anne Lester, portfolio manager for J.P. Morgan SmartRetirement Funds, says that during the hearing, the DOL and SEC "put their finger on what we think is the absolute most critical factor when talking about target date funds, which is what happens at the end" of the fund's glide path. That is, does the glide path go "to" retirement or "through" retirement?

As Ron Surz, principal of Target Date Analytics in San Clemente, California, notes, "the distinction between 'to' and 'through' funds needs to be recognized, and fund companies need to clearly label their products accordingly." Surz says the SEC may be mulling requiring fuller disclosure about the intent and purpose of individual target funds, which could include name changes. For instance, the so-called "to" funds are designed to end at the target date, Surz says, "and might be called 'accumulation-only' funds." While "through" funds are "designed to continue beyond target date, potentially to death, and might be called 'Target Death' or 'Lifetime' funds." Some industry officials opine that the target date in a lifetime fund should be year of birth, Surz says. The idea, Surz says, "is that the end date in 'through' funds is unknowable." Most see the DOL as providing some sort of guideline, perhaps regarding asset allocation and distinguishing between 'to' and 'through.'"

Tom Idzorek, chief investment officer and director of research at Ibbotson Associates, and Rod Bare, director of asset allocation indexes at Morningstar, write in the Ibbotson Target Maturity Report Q2 2009, that while it is difficult to predict what will come from the hearings, they "think the most likely action is increased disclosure requirements regarding the risk(s) associated with the [target date] funds, the amount of current and future anticipated equity exposure of the funds, and if the glide path of the fund goes 'to' retirement or 'through' retirement." Idzorek and Bare noted in the report that Ibbotson "has always felt that the use of a target retirement date in fund names is less than ideal, and Ibbotson advocates the use of birth date as a superior convention." Additionally, they said, "we prefer to use the word 'lifetime' in the naming of our solutions to emphasize that our solutions continue to glide throughout an investor's lifetime."

Surz also notes that the hearing solidified the fact that "plan sponsors are responsible for selecting and monitoring target date funds--no one else." Standards also need to be placed on target date funds. For instance, funds with the same target date may not invest alike. "A crying need remains for standards, so plan sponsors and their advisors can make informed decisions," Surz says. "The definition of quality is 'meets or exceeds standards,' so we need standards that describe the way target date funds should be structured."

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