Retirement Scholars Rip Study Finding Target Date Funds 'Exploit' Investors

Target date funds have grown quickly since coming on the scene almost three decades ago. The multitrillion-dollar industry came under congressional scrutiny recently when the Senate Committee on Health, Education, Labor and Pensions asked the Government Accountability Office to review these funds.

Many see this type of review as important as TDFs have become a common default investment in defined contribution plans. Critics worry that their strategies, which tend toward “set it and forget it,” could underperform, or that there is too much risk in these funds as participants get closer to retirement. Still others say the funds hold too few equities later in retirement, putting investors at risk of going broke.

Yet support for these funds among retirement experts is strong. For example, Christine Benz, director of personal finance for Morningstar, included in a column three reasons these funds are important: They allow investors to be hands-off, they provide cost-effective advice and they contribute to a good outcome.

But a recent study, The Unintended Consequences of Investing for the Long Run: Evidence from Target Date Funds by finance professors Massimo Massa, Rabih Moussawi and Andrei Simonov, caused some controversy.

“We document that asset managers exploit the lower investor attention to deliver lower performance,” the authors wrote in the abstract of the study, published on SSRN.

In an email, Andrei Simonov, responding for the group, said they believed TDFs are valuable financial instruments, but “we do see the problem with closed architecture, excessive use of actively managed funds (mostly not of the higher quality), and lack of clarity in glide path (and correspondingly, benchmarking troubles).”

We asked several retirement experts their opinions on TDFs and the Massa study: David Blanchett, who is managing director and head of retirement research at QMA, the quantitative equity and multi-asset solutions specialist of PGIM, and Michael Finke, professor of wealth management at The American College of Financial Services. Both are regular contributors to ThinkAdvisor. We also asked Ted Benna, known as the “Father of the 401(k),” for his thoughts on these products as well. We also asked the study authors to respond to their comments.

Finke said the controversy on TDFs surprised him because “most retirement economists view the use of [TDFs] as qualified default investments one of the most successful policy changes that resulted from the Pension Protection Act of 2006. It defaulted workers into a diversified, low-cost, age-appropriate, automatically rebalancing investment portfolio that was light-years better than money market defaults pre-2006 and the funds workers chose on their own.”

Blanchett said TDFs were “an excellent way for many investors, especially those participating in a 401(k) plan, to delegate investment management to a professional. My concern is the lack of personalization.”

The biggest problem with TDFs, Finke concurred, was “they are a one-size-fits-all solution. This makes them cheap and a good choice for most workers … [but] I see a new generation of solutions that provide both a degree of personalization and automated, low-cost investing.”

Do TDFs Lack Investment Oversight?

The Massa study found TDFs lacking in several areas. One was that “given the investor’s relative inattention, the fund manager finds himself in the privileged position of investing in the long run without the investor’s short-term scrutiny.”

Blanchett and Finke disagreed.

“You have the plan sponsor. You have a professional, a typically institutional fiduciary who is responsible for the review,” Blanchett told ThinkAdvisor. “Almost all [TDF] assets [are in] in defined contribution plans. … It’s true that the individual investors likely are not involved in the decision to pick the TDF, but someone else is. Fiduciary, by definition, is responsible for ensuring that the funds are appropriate.”

Finke agreed, writing in an email response: “The Massa study pointed out that just because many of the largest TDFs are cheap and efficient, others are not as efficient and there is potential for abuse. Why? A set-it-and-forget-it investment is by definition not an investment that is closely monitored, and firms can take advantage of the lack of oversight by throwing less competitive investments in the mix. Of course, there are fiduciary pressures to limit abusive practices.”

Simonov said in response that “if the fiduciaries do their job, then after the 2008 scandal, TDFs would not repeat the same mistake (drastic underperformance for TDFs close to retirement). And they did (in 2020). As a reminder for your readers, the target-date controversy began in February 2009 when an investigation by the US Senate Special Committee on Aging found that, among funds designed for people planning to retire in 2010, there was ‘a wide variety of objectives, portfolio composition, and risk.’”

Performance Questions

The study concluded that TDFs “deliver lower performance than other comparable U.S. equity funds” and that “TDF performance is worse the further the TDF is from its maturity date.”

Simonov added in his note that the underperformance they illustrate in the paper “is probably due to the absence of a clear benchmark and difficulties pension plan sponsors have in assessing the performance of TDFs. Our results suggest that the underperformance is more pronounced for the target date fund within the same target-date fund series with the longer horizons (so, taking the same family and comparing 2020 fund vs. 2065 fund).”