Feds taking aim at target-date funds

Defined contribution service providers are bracing themselves for new rules affecting the disclosure — and possibly the investment — of target-date funds.

The Department of Labor and the Securities and Exchange Commission have scheduled a joint agency hearing June 18 on the popular 401(k) investment options, sparking concerns that target-date funds soon will be subject to new disclosure regulations — or even new standards establishing appropriate asset allocations for the funds.

There's also the possibility that the review could spur the DOL to enhance its regulations governing the use of target-date funds as a qualified default investment alternative.

“If I had to guess, I'd say there's a pretty good likelihood that they (the DOL) are going to revisit the QDIA regulations,” said Brian H. Graff, executive director and CEO of the American Society of Pension Professionals & Actuaries, Arlington, Va. His members want the DOL to provide “more clarity” about what features a target-date fund has to include to qualify as a QDIA.

Use of target-date funds is on the front burner largely because Sen. Herb Kohl, D-Wis., has been raising a fuss about their lack of regulation — and has been urging the SEC and DOL to subject the funds to new requirements.

Under rules adopted by the Bush administration's DOL in 2007, the regulations governing the use of target-date funds as a QDIA say they must be invested in a mixture of equity and fixed income, and change their asset allocations over time “with the objective of becoming more conservative.”

Mr. Kohl, chairman of the Senate Special Committee on Aging, is upset because an investigation by his committee has revealed that 2010 target-date funds — designed for people who will retire in 2010 — offered by various mutual fund companies had wildly different asset allocations between equities and fixed income last year, with many of the funds investing more than half their assets in stocks.

One 2010 target-date fund lost more than 40% of its assets in 2008, Mr. Kohl wrote in a Feb. 24 letter to Hilda Solis, secretary of labor: “A loss of this magnitude simply should not occur in a financial product that was designed and is specifically advertised to limit risk and volatility as one nears retirement.”

What Mr. Kohl wants the SEC and DOL to do, according to Ashley Glacel, his spokeswoman, is to establish rules and regulations setting standards for asset allocations within target-date funds.

“At this point, you can call anything a target-date fund, but it might not be doing what a target-date fund says it will do,” Ms. Glacel said. “If you're going to call it a 2010 target-date fund, it better be pretty darn conservative as you get closer to 2010.”

One possible solution, being promoted by Mercer Bullard, founder and president of the advocacy group Fund Democracy Inc. in Oxford, Miss., and Barbara Roper, director of investor protection for the Consumer Federation of America, Washington, would be for the SEC to regulate misleading fund names to ensure that asset allocations were appropriate.

“The idea is that they (target-date funds) should be within a reasonable range of asset allocation given the target date,” Ms. Roper said.

Representatives of major employer groups oppose additional regulation of target-date funds, partly on the grounds that the asset allocations of the funds — and the glide paths describing how the fund's investments will move toward more conservative fixed-income investments over time — are already disclosed to plan participants in mutual fund prospectuses.

Some argue the equity allocation of target-date funds has only become an issue because the stock market tanked last year.

“To make these rash judgments based on a real aberration in the market doesn't make any sense at all,” said Ed Ferrigno, vice president of Washington affairs, Profit Sharing/401(k) Council of America, Chicago. “In an extreme bull market, the same people would be arguing that the target dates weren't aggressive enough.”

Employer group lobbyists also argue that adopting Mr. Kohl's recommendations could undermine a key principle in the Employee Retirement Income Security Act charging plan sponsors with the fiduciary obligation to pick plan investments appropriate for their plan participants.

“Each company has different demographics, and they will choose a fund for what works for their demographics,” said Mark Ugoretz, president of the ERISA Industry Committee, Washington. “The idea that you can have a cookie-cutter target-date fund makes no sense, and we would be opposed to that.”

“There are not any easy answers here,” added Judy Schub, managing director of the Committee on Investment of Employee Benefit Assets, Bethesda, Md. “What might be an appropriate amount of risk for one work force might not be appropriate for another, and those are issues the fiduciary and plan sponsor have to look at.”

Among mutual fund company executives, who package and market many target-date funds offered to DC plans, the consensus is less clear.

Robert L. Reynolds, president and CEO of Putnam Investments, for instance, has endorsed the concept of limiting the amount that could be allocated to equities in target-date funds as participants near retirement (Pensions & Investments, May 18).

Putnam spokeswoman Laura McNamara said Mr. Reynolds believes the industry or federal regulators should “impose a cap on how much age-based funds allocate to stocks as they close in on retirement.” Ms. McNamara also said Putnam's Retirement Ready 2010 Fund currently has an equity allocation of 28%.

Executives at Fidelity Inc., Boston, meanwhile, don't “believe Congress or regulators should mandate how investment products are designed or restrict asset allocations,” said Jenny Engle, a Fidelity spokeswoman. “We believe policymakers should be product-neutral, enabling and encouraging investor and plan sponsor choice.”

Kristi Mitchem, head of the defined contribution business at Barclays Global Investors, San Francisco, said she believes the SEC and DOL hearing will ultimately result in more disclosure for target-date funds.

“If it (the additional new disclosure) is done in the right way — if it's clear, easy to produce and easily digestible to the participants — we would support it,” she said.