From the October 2009 issue of Investment Advisor • Subscribe!

More Challenges for Target Date Funds

Manager investment in target date funds sorely lacking

Target-date mutual funds, once the darling of the industry, need lots of improvement when it comes to better practices by managers and fund companies, from more detailed and comprehensible disclosures to better manager investment, according to a new target-date research paper by Morningstar, Inc.

Morningstar researchers found, for instance, that managers appear to have little "skin in the game," in terms of investing in the target date funds they manage. Manager investment is "severely lacking," the report found. Of the 58 target-date fund managers that Morningstar studied for manager investment, only two had investments greater than $500,000. The threshold is $1 million for full credit for management ownership in Morningstar's system. "It is disappointing," says Laura Lutton, Morningstar's editorial director for mutual fund research. Target-date funds are designed to be a core holding in one's portfolio, so the lack of conviction displayed--and Lutton says she has heard every excuse from CEOs for the lack of manager investment--reveals that managers of target-date funds are not as confident about performance as the companies' marketing departments.

"Across the board, investment is poor," Lutton says. "I have heard CEOs who say, 'I don't think that matters.' But we have data that say it does," she says. "I hope this is an area where we see some improvement over the years, and I think we will."

Morningstar's research also found that target-date funds have a very wide range of asset allocations the closer the investor is to retirement. The report says the variation can be dramatic. As investors age, some fund series stay aggressive with a high percentage of equities while others place more emphasis on asset preservation.

The divergence of glide paths are lost on many investors and fiduciaries, according to the report, and are not explained well, and it is those differences and lack of understanding of the glide paths that led to the shock over many of the 2010 funds' poor performances in 2008.

"Because these funds differ so much from one to the next, it's really critical for investors to understand what they own," says Lutton, "and that's a challenge because the public disclosure from the fund companies is lacking."

Asset allocation, manager selection, how the funds were designed, and how they will perform can all be more transparent, timely and clear, according to Morningstar. It is tough or nearly impossible, the researchers wrote, for individual shareholders to figure out how their target-date funds work.


Elizabeth D. Festa is a freelance business writer based in Washington, D.C. She can be reached at elizabeth.d.festa@comcast.net.

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