October 1, 2010

Manning & Napier’s Cunningham on Target Date Funds: The Weekend Interview

Argues government "should not be in the business of telling people what their glide paths should be'

When the comment period on the Securities and Exchange Commission's proposed rules on target date funds closed on Aug. 23, the SEC received only 44 recommendations from industry officials and lawmakers. That number was unusually small, considering the growing popularity of target funds—and the controversy surrounding them.

Assets of target date funds registered with the SEC now total approximately $270 billion, and yet many investors don’t understand the risks and benefits associated with this increasingly popular retirement-savings vehicle. Indeed, when the markets tanked in 2008, target date funds themselves became a target of criticism. The big complaint was that many funds’ asset allocations contained an unduly high percentage of money-losing equities for people who were hoping to retire in 2010.

In response, SEC Chairman Mary Schapiro asked her staff to prepare recommendations about how target-date funds are marketed, and on June 16 the SEC proposed rules that would help clarify the meaning of the date in a target-date fund and improve the information provided when these funds are advertised.

Schapiro also said that the proposed rules "would enable investors to better assess the anticipated investment glide path and risk profile of a target-date fund by, for example, requiring graphic depictions of asset allocations in fund advertisements." The rules also "would require an asset allocation 'tag line' adjacent to a target-date fund's name in an advertisement," she said.

While the 44 responses to the SEC’s request for public comment were few, they came from major players in the world of target-date funds, including Harvard Law School’s Pensions and Capital Stewardship Project, corporations such as BlackRock and Morningstar, and industry and lobbying groups such as the Association for the Advancement of Retired Persons (AARP).  All 44 comments on the rule amendments have been published in the Federal Register.

Asset Allocation Tag Lines Questioned

One such comment came from Manning & Napier Advisors Inc., a $30 billion Rochester, N.Y.-based asset manager that has long specialized in target-date funds. Manning & Napier’s Patrick Cunningham, who was appointed CEO in June and is the first to lead the firm since founder Bill Manning retired, spoke about his firm’s position on the SEC’s target date rule proposal in a Sept. 21 interview with AdvisorOne.

Overall, Manning & Napier supports the SEC’s desire to increase investor awareness and understanding of target date funds via greater disclosures. But according to comment writer Jeffrey Coons, Manning & Napier’s president, the firm disagrees with the proposal to require asset allocation tag lines in or near the name of a target date fund because placing too much emphasis on the target date asset allocation unduly ignores the retirement period following the target date.

During the interview, Cunningham discussed trends in the target-date fund industry, in which he has participated for more than 25 years. He touched on issues ranging from the SEC’s potential regulations, to investors’ retirement savings, to the future of the lifecycle industry.

Advisor One: You sent your letter to the SEC just under the wire, on Aug. 23—the same day that the comment period closed. Why did you write your letter to the SEC?

Cunningham: We’re passionate about our business, and we believe that lifecycle target date funds play a valuable role for retirement. The statistics show that when people make their own asset allocation decisions, the average investor does a very poor job. A Dalbar Inc. study shows that over the last 20 years, the average return of the S&P 500 has been close to 10% compared to how the average equity mutual fund investor does, which is closer to 4% per year.  People trade on emotion, whether it’s optimism or pessimism, and that typically results in the wrong decision at the wrong time. Having someone do the asset allocation for the participant has great value.

‘There’s Something Wrong With This Mousetrap’

AdvisorOne: Please spell out the basic problem that the SEC is studying.

Cunningham:  Sen. Herb Kohl, D-Wisc., was one of the leaders in pointing out some of the deficiencies with lifecycle funds, and rightfully so, in our opinion. The issue is that in 2008, we saw people who were about to retire in 2010 lose a third of their money in certain lifecycle 2010 funds because we were in a bad market in 2008 that continued into 2009. If I’m about to retire, and I just lost a third of my money, there’s something wrong with this mousetrap. That’s why the SEC and the finance community in Congress started looking into this and asking, “What’s going on?” The first thing they realized was that different mutual fund providers have very different glide paths.

AdvisorOne: What is a glide path, and what is the issue at stake?

Cunningham: A glide path is the trajectory of asset allocation over time. For example, most glide paths are literally just that: a line or a curve that says, “If you’re in a 2050 fund, today that 2050 fund will have 80% in equities. By the time we get to 2045, it will be closer to 25% in equities.” It’s a path that slowly gets more conservative the closer you get to retirement because a) you don’t have the time to live through a big decline so you better be more conservative, and b) if you start to withdraw income, you have to dampen the volatility to provide for those withdrawals over the longest amount of time.

Every mutual fund company has a glide path based on “to or through,” meaning some companies get to their most conservative asset allocation at the age of 65, or the target date. Some companies get to their most conservative allocation sometime after retirement; it could be six to 10 years after. Everyone approaches it differently. There were some 20 10 funds that had closer to 20% in equities, and others that had closer to 60% in equities in 2008 and 2009. So you had the same target date, yet a very different asset allocation. In 2008, you’d expect a 2010 fund to be fairly conservative. Some were conservative, but some were quite aggressive.

Everybody had a slightly different interpretation of what the glide paths should look like. The Senators are now saying, “Hey, come on, we need a lot more transparency. We need to see what the glide paths are!” When the SEC asked for comments, that’s one of the first points they noted, and we wholeheartedly agree: Show the facts.

I think it’s inevitable that there will be greater transparency about the target-date funds’ glide paths. I also think that the government should not get into the business of telling people what their glide paths should be. That’s not part of the regulations or what they put out for public review, but early in the discussion mandating the glide path was talked about.

Glide Path Transparency Is Essential

Advisor One: What kind of action do you expect to see the SEC take with its target-date rule proposal, and what kind of action do youwant the SEC to take?

Cunningham: There are two aspects of their guidelines that we strongly support. One is being open about the glide path, and two is being open about the underlying portfolios. Certain mutual fund companies have funds of funds, so in their target-date fund, the underlying investments are 25 different mutual funds. When you look at the mutual fund, you’ll see that it holds 25 other mutual funds.

The question is, what are the underlying holdings of those 25 mutual funds? If XYZ mutual fund has 250 stocks in it, and ABC mutual fund in the same lifecycle fund has 300 stocks in it, let’s see what those underlying stocks are. Don’t just tell me I have a large-cap growth fund. Tell me what’s inside all of those underlying funds. I can go to Morningstar and look up what the underlying holdings are, but the average investor can’t do that. Believe me, it will be confusing, but for people who need and want to know, they will have the information to evaluate. Disclosure is important.

AdvisorOne: Why don’t you think the government should regulate glide paths more closely?

Cunningham: Glide paths are constructed based upon long-term averages of markets. Manning & Napier has what we call a “glide range.” For our 2030 fund, we can go anywhere from 40% to 70% in stocks at any point in time. For our target 2020, we have a glide range of approximately 36% to 68% of stocks. Our target 2010 can go anywhere from 20% to 60%. My point is that it’s a fairly wide range.

For example, in March 2009, we were at the high end of the range because stocks were so cheap. There was such abject fear in the marketplace that we could pick up some of the best companies in the world at valuations that we hadn’t seen in decades and probably will never see again for decades, whereas at the end of 1999 and into 2000, we were at the lower end of our ranges because everything was so expensive. The stocks we wanted to own weren’t trading at a discount to their fair market value. We firmly believe that people who invest in lifecycle funds want risk management. They want someone who is going to protect their assets when things get ugly. The best way to do that is active asset allocation, being overweighted in stocks when they’re cheap and underweighted when they’re expensive.

Read more about the SEC’s target date fund proposalat AdvisorOne.com.

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