Target-date funds now represent more than 50% of all 401(k) assets. They deserve more fiduciary oversight by regulatory structure and by internal policy — not less.
The insurance industry is making a major push for lifetime income annuities, and the best way to hide these high-risk high fee products is in a non-transparent target-date collective investment trust, or CIT. The private equity industry also loves target-date CITs, where they can hide alternative investments.
To correctly manage and evaluate target date funds, investors need full transparency, not only to the asset class level but to the security level within the different asset classes.
We have access to this transparency in SEC-registered mutual funds, but retirement plans need to do the extra analysis of looking down to the sub-asset classes by allocations to look at fees and performance. Some CITs have full transparency down to the security level, such as Vanguard and Fidelity, but many do not, and can hide high fees and high risks.
Target-date funds are the dominant default option or QDIA (qualified default investment alternatives) in most retirement plans resulting in the highest level of fiduciary responsibility. They are the most non-transparent plan investment option and the easiest way to hide fees and play performance games. Despite the high level of fiduciary risk, they are specifically designed to avoid accountability and thus need the most scrutiny.
I believe target-date funds were created to sustain higher fees with the influx of indexing, and Wall Street continues to create ways to exploit these. These types of manipulations are difficult in transparent SEC-registered mutual funds.
Target-date fiduciary standards
In late September 2023, former Assistant Labor Secretary Phyllis Borzi and I briefed the White House Office of Management and Budget and the Department of Labor on the proposed fiduciary rule now out this spring. I emphasized the severe fiduciary issues that surround contract products like annuities and private equity. I urged the need for strong fiduciary standards, especially as annuities and private equity are being put in target-date funds, which are QDIAs and which need the highest level of transparency and accountability.
There is a general assumption that CITs are regulated by the federal Office of Comptroller of the Currency. Some CITs are regulated by the OCC, while most used in 401(k)s are regulated by one of 50 state bank regulators. This allows CITs to choose their own state regulator who may or may not have lax oversight. While SEC-mutual fund regulations are not perfect, they do control for a lot of risks and provide a good amount of transparency.
For the past few years, the insurance industry has pushed legislation and heavily advertised for lifetime income annuities. Most large retirement plans have resisted, realizing that 100% single entity credit risk and liquidity risk is a serious fiduciary issue and would probably be a prohibited transaction without exemptions.
The industry's new tactic is hiding these strategies in poorly state-regulated CIT target-date funds and hope that no one reads the fine print on these contracts.
Plan sponsors should always document in their 401(k) plan minutes the following regarding target-date funds:
• The plan’s investment policy statement should include provisions on selecting and monitoring target-date funds. Does it address each asset class involved in the plan including inside the funds?
• Each asset class in target-date funds should be fully evaluated in terms of risk, fees, and performance as if they were a standalone option.
• Assets that are not SEC-registered mutual funds or registered securities such as private equity and annuities need additional scrutiny and documentation.
• Additional documentation, including a request for proposals (RFP), should be required if the plan is using a record-keeper vendor’s proprietary target-date funds.
• Select an appropriate benchmark to evaluate each asset class in the funds. Compare and justify the attributes of your fund if it has differences with the benchmark.
• Understand the different fees and compare fund family fees, bearing in mind that target-date funds have multiple layers of fees.
• Do an RFP for target-date funds at least every five years.
• Carefully document the reasons that the fund was selected. Regularly monitor the funds.
• Document any and all reasons for not removing retained funds if performance or fees has lagged peer funds.
Chris Tobe, CFA, CAIA, has over 20 years’ experience working with 401(k) investments as a consultant and currently is the chief investment officer for Hackett Robertson Tobe. This content represents the views of the author. It was submitted and edited under Pensions & Investments guidelines but is not a product of P&I's editorial team.