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Retirement Planning > Retirement Investing

The Retirement Time Bomb No One’s Talking About ... Yet

By Gil Weinreich

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The problem of insufficient retirement savings is an oft-highlighted problem, but the safety of Americans’ meager retirement assets gets far less attention.

Ron SurzSo says Ron Surz (left), pension consultant and gadfly on target-date and hedge fund issues who has written numerous technical articles on portfolio management.

In an interview with ThinkAdvisor, Surz warns that masses of retirement portfolios are due to blow up, just like they did in 2008, because of the inappropriate risk levels of target-date funds, which today claim a far higher proportion of retirement assets than they did back then.

“It’s not a matter of if — it’s a matter of when, says Surz of San Clemente, Calif.-based Target-Date Solutions. “We will have another market correction and those folks at or near retirement will be toast,”

While both diversification and fund costs have improved somewhat since the 2008 financial crisis, the key factor that is unchanged since that time is the riskiness of these funds.

“The equity allocation is exactly what it was in 2008,” Surz says, noting that target-date assets have skyrocketed since that time.

The fund category, which combines stocks and bonds but which reallocates in order to become more conservative as the investor approaches retirement, has surged in growth since the Pension Protection Act (PPA) of 2006 made TDFs (the most popular) one of three default investments.

From zero assets prior to the PPA, target-date funds today amount to more than $1 trillion, or about one fourth of all 401(k) assets, and are on track to reach $4 trillion, or half of all 401(k) assets, by 2020.

And yet, as the financial media mark the fifth anniversary of the Lehman Brothers bankruptcy, which sent the stock market into a tailspin, Surz wants Americans to recollect that target-date funds, despite their image as safe investments, performed abysmally at that time.

Investors — some already retired and others close to retirement — in 2010 target-date funds (i.e., funds invested for investors targeting that year as their retirement date), lost 25% of their funds’ value on average in 2008.

The Securities and Exchange Commission and Department of Labor held hearings at which fund company executives assured officials that all was well.

“As soon as they made back 25%, the fund companies were saying no harm no foul. This will never happen again. It’s a pretty naïve view,” Surz says.

That is because fund company incentives are not aligned with retirees’ goals, which is to not risk losing their retirement wealth when they need it.

“The fund companies get paid whether performance is good or bad, and they get paid more for running higher risk products. They get paid for more for running a stock portfolio than a bond portfolio,” Surz says.

And indeed, Surz points out that the three fund companies that collectively manage 85% of target-date fund assets — T. Rowe Price, Vanguard and Fidelity — have average equity allocations of 60%, 55% and 55% respectively, a level of risk Surz says is inappropriate.

(While unchanged on average since 2008, he notes that 2010 funds specifically averaged equity allocations of 45% when they lost 25% in 2008.)

Beyond these averages, Surz finds it curious that some companies have widely different allocations that seem to reflect corporate objectives more than investor objectives.

For example, PIMCO, a bond shop, has just a 20% average equity allocation at the target date, whereas AllianceBernstein, an equity shop, has a 70% equity allocation.

“In their presentations, they’ll tell you that PIMCO’s demographic is people who have saved enough and don’t need to take risk and AllianceBernstein’s is people who haven’t saved enough and need to take more medicine [i.e., equities],” Surz says.

“But look at their prospectuses: You will not see these objectives; they’re just an excuse to package product any way they want to.”

He adds that each has its Ph.D. presenters who will “prove to you that 70% of the target-date portfolio should be in equities [for AllianceBernstein while] Pimco will prove to you that 80% should be in bonds.”

The reality, he says, is they allocate their funds the way they do for two reasons: “They want to get paid most they can and they want to win the horse race” — meaning they understand that equities usually outperform, so (PIMCO notwithstanding) they’re going to load up on stocks so they have good performance numbers most of the time.

Surz, who has developed his own Smart Funds available to RIAs through Hand Benefit & Trust of Houston, says advisors must play the key fiduciary role.

The plan sponsors who are obligated as fiduciaries for workers “are just plain lazy,” Surz remarks. “These guys are running companies, not pension funds.”

Five-year losses for his Smart Funds were just 10% in the five most brutal months of 2008, compared with 37% for T. Rowe Price, 30% for Vanguard and 35% for Fidelity.

Surz has spoken to ERISA attorneys who are already planning class-action lawsuits against mutual funds (rather than shallower-pocketed plan sponsors) when the next crisis hits.

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Check out Beware of Target-Date Funds by Ron DeLegge on ThinkAdvisor.

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