Wyatt Lee walked into the Retirement Income Symposium in Chicago Tuesday, filled with RIA representatives, and immediately addressed the elephant in the room—what happened with target-date funds?

Target-date funds haven’t performed to expectations, despite glide-path tinkering and retirement date changes.

“Nonsense,” says Lee (left), the vice president of T. Rowe Price Associates, Inc., and associate portfolio manager of the T. Rowe Price Retirement Funds, which manages $53 billion in assets. Lee began with a defense of the product, noting too many clients—and advisors—misunderstand their intended use.

“They performed exactly as they should have,” he said. “The problem is that there was a large disparity in performance, which confused the public. What they didn’t realize is that they don’t all perform the same. Just as with every other fund product, target-date funds have good and bad performers.”

He noted target-date fund growth had been significant, and despite on-going controversy, target-date assets continued to grow. According Lee:

  • 31% of participants at year-end 2008 who were invested in target-date funds, up from 25% at the end of 2007.
  • 23% of participantsin their 20s who were invested in target-date funds at year-end 2008 compared to 19% at year-end 2007 and 16% at year-end 2006.
  • 94% of consulting firms that “believe target-date strategies will continue to be the most prevalent form of investment default in DC plans.”
  • 75% predicted percentage of all 401(k) assets that will be held in target-date funds within five years.

But their growth has attracted more regulatory scrutiny, including testimony from a number of fund families before the Senate Banking Committee.

“Once the regulators and legislators heard about the benefits and how they actually worked, they became satisfied and comfortable with them for the general public,” he said. “But the consumer press has not, and that’s where a lot of the controversy still comes from.”

He then ticked off the “benefits” to which he referred, including:

  • Turnkey solution for plan sponsors and participants
  • Age appropriate asset allocation
  • Broadly diversified portfolios
  • Ongoing account rebalancing and reallocation
  • Addresses longevity, market and inflation risk
  • Automatic “default” solutions address behavioral issues
  • Automatic enrollment
  • Automatic investing

The main issue, he said, is understanding and accurately developing suitable “glide path” structures, or the allocation adjustments needed as retirement approaches.

“The question becomes a question of allocating ‘to retirement’ or ‘through retirement’,” Lee said.  “Too many target-date funds only get the shareholder to a specified retirement date. But the client will still unquestionably need to be invested throughout their retirement. We think the ‘through retirement’ model is superior, and that’s why our target date funds work so well.”

“To” fundsare designed for an investor who expects to spend all or most of his or her money in the fund at the target date. This strategy focuses on providing more certainty in anticipation of a rapid drawdown of assets in retirement. It’s a strategy that is typically associated with a lower equity allocation.

“Through” fundsare designed for an investor who plans to withdraw the value of the investor’s account in the fund gradually after retirement.This strategy focuses on providing an income stream throughout a long retirement. A “Through” strategy is typically associated with a higher equity allocation.