The Wall Street Journal reported that the Securities and Exchange Commission will begin examining the marketing of retirement products known as target-date mutual funds. “SEC to Examine Marketing of ‘Target Date’ Funds,” Feb. 6, 2010, by Fawn Johnson.
Target date retirement funds are marketed as a simple and easy way to automatically lower the risk in your portfolio as you get older. Target-Date mutual funds are supposed increase the allocation of bonds over time in order to reduce volatility as an investor approaches retirement. Stocks are generally more volatile than bonds, and investors generally increase the percentage of bonds to add the stability to a portfolio of investments.
It sounds good in principle, but target date funds have been found to vary wildly in their allocations of stocks and bonds. The percentage of stocks in funds called Target 2010, which are aimed at people hoping to retire in the year 2010, ranged from a relatively conservative 21% to a much higher-risk 79%, according SEC Chairman Mary Shapiro. See Leslie Wayne’s June 25, 2009 article in the New York Times entitled “Target-Date Mutual Funds May Miss Their Mark.” The average 2010 fund had more than 45% of its holdings in stocks in 2008.
The Fidelity Freedom 2010 Fund contained 50% stocks and lost 25% of its value, and the AllianceBernstein 2010 fund had 57% stocks and lost 33% of its value, according to the article. Some of target-date funds fared even worse – losing 40% to 50% of their value ? more than the S&P 500 (100% stock) index, which fell 38.5%.
“Funds with the same target date in their names can be structured, and thus perform, very differently,” says Ms. Shapiro.
In 2006, Congress passed legislation that enabled employers to route employees who did not specify their investments into target-date funds. Consequently, money flowed into such funds in unprecedented amounts. Before that, the default choice was generally a money market or “stable value” fund.
Last June, the SEC was reportedly considering whether putting a date in a fund’s name should be prohibited, as well as whether the risks have been adequately disclosed and whether the funds were properly structured.
Representative Rob Andrews, Democrat from New Jersey, expressed concern that mutual fund companies are not making adequate disclosures or offering other choices to 401(k) plans, such as low-cost index funds. Mutual fund companies often create target-date funds by bundling existing funds. This practice enables the fund companies to collect more fees than investors understand they are paying. “I’m not saying that pensions are being pillaged by greedy mutual fund companies,” said Representative Andrews, “but I am saying that that people should know how much they are paying and that investment advice should be in the best interest of the investor, not the advisor.”
If the SEC does not act, Congress says, it will. Senator Herb Kohl, Democrat from Wisconsin and Chairman of the Special Committee on Aging, has criticized aspects of target-date retirement funds. “At the end of the day, consumers need to know what they’re getting into,” Senator Kohl said. “We’d like to see regulation, whether it’s a standardization of target-date composition, or increased clarification of information made available about the plans.”
So, now the SEC says it will act ? sometime this year. Ms. Johnson’s article did not indicate that anything would be done to standardize target date fund composition. “In the year ahead, we are going to confront the issue of the potential for target date fund names to confuse investors, or lull them into a false sense of security,” Ms. Shapiro said. “I have asked the staff to prepare a rule proposal to provide additional information to investors when a fund includes a date in its name,” she added.
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