The investment losses of target date funds in 2008 has drawn the attention of both the politicians and the regulators. They are particularly concerned about the losses incurred by participants who are close to retirement age, for example, those who are investing in the 2010 fund.

The average losses for 2010 funds in 2008 was approximately 25%, while the 2010 fund of one mutual fund company lost over 40%. Those are staggering losses for participants who were told, in effect, that they were appropriately invested based on their age. The Senate’s Special Committee on Aging has recently held hearings on target date funds, the reasons or the losses, the descriptions and communications of the purpose and structure of the funds, and other issues. In June, the Department of Labor and the Securities and Exchange Commission held joint hearings on similar issues.

What is the likely outcome?

While it appears that target date funds will continue to enjoy the status of a qualified default investment alternative (QDIA) and, as a practical matter, will continue to be structured in much the same way, there will be a much greater focus on those funds, including:  

      • What does the year (for example, 2010) in the name of the fund really mean?
      • How does the manager of the target date fund make decisions about the operation of the fund?
      • What information should be communicated to plan fiduciaries and participants about the character and risk of their funds?
      • What does that mean for plan sponsors and the officers who serve as fiduciaries?
      • Target date funds are now subject to the same scrutiny as other mutual funds. They must be prudently selected and monitored and, if they are not satisfactory, they must be removed and replaced.
      • When engaging in that process, plan sponsors should focus primarily on the funds for their older employees, such as the 2010 fund, 2015 fund and 2020 fund. That is because—surprisingly—the greatest differences in the design of the funds are for older employees. And, in those later years, when account balances are the highest, the funds can produce the greatest gains or the greatest losses.
      • Plan sponsors should ask their advisers and providers, at the least, the following two questions:

- Are my target date fund aggressive or conservative when compared to the universe of target date funds?

- Are my target date funds designed for the glide path to end at retirement or does the glide path continue for years beyond that?

Equipped with that information, plan sponsors need to decide whether the design of the target date fund is appropriate for their participants.

As the preceding statement suggests, plan sponsors need to focus on the needs of their participants. For example, a law firm might use aggressive target date funds because, by and large, the employees of a law firm have flexibility to retire earlier, or retire later, depending on the investment performance and size of their 401(k) accounts. However, an employer with a workforce where the employees lack that kind of flexibility (or where there may be large layoffs in a recession) may decide that large investment losses pose a greater threat to its employees than any benefit that would be gained from large investment gains. In other words, those plan sponsors might select a conservative target date line-up.

This is just the beginning of this story. There is much more to come, including reports from those hearings and the possibility of additional regulation and disclosure.

Source: Report to Plans Sponsors