SEC is not helping you with target-date funds

April 29, 2014 

Years ago, one of my relatives went to a hypnotist hoping, effectively, for a magic spell to alleviate a big personal fear. Whenever she came face to face with that fear, the hypnotist told her, rub something between her thumb and forefinger and say, repeatedly, “This man is helping me.”

She didn’t get much relief from the problem.

Years later, I’m amused to find that the Securities and Exchange Commission seems to be trying to pass off a similarly ineffective cure when it comes to fears some investors have about the risk in target-date funds.

Target-date investors could say repeatedly that “The SEC is helping me,” but that won’t make it true.

At issue is how target-date funds are positioned in advertising and fund documents. The dilemma was supposed to have been solved a while ago, but regulators and fund companies seem to be at constant odds over the issues, so the SEC recently reopened the comment period for its proposed rule on target-date names and marketing tactics.

Target-date funds — also known as life-cycle funds — should be “one for a lifetime,” where investors buy a portfolio that adjusts to become more conservative as the shareholder ages. Alas, different fund firms take divergent strategies, disagreeing mostly on a fund’s “glide path,” industry jargon for whether a fund simply arrives at retirement age, or stretches out the landing for the rest of shareholders’ expected lives.

It’s the difference between “to” and “thru,” and it’s both semantic and significant, which has addled the regulators.

Think, for example, of a 2020 fund, aimed at an investor who is now about 60 years of age (meaning they’ll be 65ish when the target date is reached).

When 2020 arrives, a fund that goes “to” that year would have a one-size-fits-all portfolio for someone age 65. It might be 60 percent stocks, 40 percent bonds, or maybe half stocks, 40 percent bonds and 10 percent cash; whatever management’s formula, once it hits the target date, it remains static.

By comparison, a fund that goes “thru” 2020 could have the same asset-allocation at that point, but would become more conservative as more years pass.

Allocations matter, as was proved in 2008 when target-date funds — including the most-conservative, close-to-maturity issues (think target-date 2010) — were crushed. That’s what made the politicians and regulators want to step in to this matter in the first place.

The perceived problem was exacerbated by fund industry honchos. The funds with the biggest equity positions — the ones most crushed by the market’s downturn — had been big winners for years leading up to the fiasco; more-conservative funds — which had lagged their peers for years until the downturn — did a lot of finger-pointing and “told you so” to suggest that this key new business was rife with danger.

It wasn’t then and isn’t now.

That doesn’t minimize the issues. Of all fund types, target-date funds have among the lowest redemption rates, meaning investors buy them expecting to hold them for a lifetime, and typically do just that. That makes them crucial business for investment firms that want to game the system and attract assets any way they can.

The SEC can’t come to grips with how to rein things in largely because it doesn’t want to offend fund companies; it’s trying to calm political fears by addressing a problem that is mostly in the heads of industry insiders and politicians with an agenda.

Consumers don’t care about the head games; they just want to understand what they are buying. With ratings firms such as Morningstar having more than 50 categories for target-date issues — even though most are differentiated mostly by year — average investors feel a bit bamboozled.

The SEC will say it is helping shareholders and will come out with a proposal that is all about how a fund’s glide path is illustrated and more.

It’s hypnotic, but ineffectual.

There’s a remarkably simple solution available: Make “target-date” and “life-cycle” meaningful terms. A target-date fund is “to” the target date, ending with a portfolio appropriate for someone who’s about 65 years old at that point. A “life-cycle fund” should take investors through to the end of their lives.

Thus, a “to fund” would specify a year (think XYZ 2040), and a “thru fund” wouldn’t, including instead an investor’s current age and a descriptor, making, say, XYZ 50 Conservative appropriate for a “50-year-old conservative investor.” The number changes, with age, every five years (so, XYZ 55 Conservative), and the underlying portfolio adjusts to remain age-appropriate.

The SEC doesn’t need to make this issue more complicated than that.

It will, however; you can count on that.

The moral of the story: Dig deep before simply defaulting into a life-cycle fund, so that you at least know if it will take you to retirement age or thru it. And if you are expecting regulators to make it easier for you, get a grip on reality, because that’s just not happening here.

Chuck Jaffe is senior columnist for MarketWatch. He can be reached at cjaffe@MarketWatch.com or at P.O. Box 70, Cohasset, MA 02025-0070.

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