Because we're in the business of providing asset management services to defined-contribution retirement plans, and because we care about the retirement security of our fellow citizens, we take a special interest in discussions of "target-date" mutual funds (see this, for example).
So we were delighted to see Tom Lauricella's semi-recent (and delightfully-titled) riff on target-date funds in The Wall Street Journal. Here's the bulk of Lauricella's short piece, with each excerpt (in blue) followed by our observations (in black):
With many target-date mutual funds inflicting big losses on investors nearing retirement, they've gone from hero to goat.
If history is any guide, these funds are still a better option in the long run than less-volatile alternatives like money-market funds -- a plus for Congress's decision to make it easier for employers to automatically direct employees' retirement money into target-date funds. But their poor performance is leading to scrutiny of how fund companies construct and market these portfolios.
Indeed. In the time-honored tradition of "follow the money," it's all about the construction and marketing of these things. More on these two factors below.
As we've noted here before, the true finish line is one's life expectancy, not the day one retires. But the intervening moment of truth is the point at which an investor annuitizes a corpus of assets, turning that accumulated wealth into a stream of income (through an insurance product or a systematic withdrawal program).
Again, quite true. The clear imperative is to give participants (and other investors in these vehicles) plain-English versions of the relevant information, not thick prospectuses and statements of additional information.
Congress, somewhat belatedly, is looking more closely at target-date funds as default investments in retirement plans. One question is whether it should dictate investment-mix parameters -- or at least make it clearer that a 2010 "retirement" fund is actually a 2035 "death" fund.
This is why we favor a "target-risk" approach rather than a target-date model. We think the notion of risk-calibrated portfolios goes to the core of the problem, focusing on what really matters (expected risk and return parameters) rather than the wholly subjective premise of a future year when the difference between the "retirement fund" concept and the "death fund" concept can be very consequential...and totally opaque to most plan participants. If we're going to put rank-and-file participants in charge of their own investments, we simply must give them relevant information as straightforwardly as we can.*
Some say there are more-fundamental issues to examine. Laws covering retirement plans were intended to ensure they are run in the sole interest of participants. There are prohibitions against "self dealing" by the fiduciaries. Mutual funds, however, are given a pass on these conflict-of-interest rules. That allows fund firms to build target-date portfolios with a tilt toward higher-fee stock funds, rather than low-fee bond funds. Even if that weren't a motive for asset allocation, in a bull market like the one through late 2007, the more stocks, the easier it is to attract clients.
This is really the central problem with proprietary target-date funds. Here, the construction and the marketing of these vehicles can produce some decidedly unhelpful cross-mojonation, contaminating the (legally/presumably) fiduciary function of portfolio assembly with the non-fiduciary imperatives of profit-making. Which is why Lauricella's last paragraph is his most important.
Another possibility is requiring 401(k) target-date funds to use asset-allocation models developed by a company not affiliated with the fund manager, in order to avoid conflicts of interest.
This is clearly the way to go, ensuring, when combined with rules governing advisors' compensation, a high degree of independence on the part of the professionals who assemble these portfolios.
One key, then, is to separate fund companies' profit-making imperatives from the process of portfolio construction. The easiest way to do that is precisely as Lauricella describes, using independent advisory firms to construct portfolios (preferably of the target-risk variety) using the best-available products from all fund companies, not just one.**
The second key is to communicate expected risk and return parameters to participants in simple, accessible terms, enabling them to make easy, informed decisions before returning to what they do best: working, deferring assets into the plan, and enjoying their lives without feeling the need to constantly monitor and tweak their 401(k) portfolios.
* By "we," we mean plan sponsors and fiduciary service providers.
** For what it's worth, we use 15 funds in our 401(k) portfolios. Ten of those are Vanguard funds. Currently, the other five are Fidelity, T. Rowe Price (2), Alpine, and Pimco products. This list is always subject to change, but we'll only change it if we're convinced that some alternative vehicle would be better for plan participants and their beneficiaries.
Tom Lauricella, "Let's Set a Target, And Date, for Fixing Target-Date Funds," Wall Street Journal, April 6, 2009
Fred Reish, Bruce Ashton, and Jason Roberts, "Investment Advice for Participants: Prohibited Transactions and Level Fee Advice," Reish Luftman Reicher & Cohen, March, 2009