Thursday, December 9, 2010

Target date fund guidelines miss the problem

SEC guidelines for target date funds and disclosure miss the critical problem with these very popular products. They don't do what consumers THINK they do. Target date funds make investing easy for long term investors in 401k and other DC pension schemes by promising to make systematic asset allocation changes that reduce the equity exposure of the portfolio as retirement, or the target date approaches. As a result, 80% of all new and redirected assets into U.S.-based DC plans are flowing into these funds. 77% of assets in these products are controlled by three manufacturers, Fidelity, Vanguard, and T. Rowe Price who must bear much of the responsibility for the misdirection.

By suggesting that equity exposure is being reduced over the life of the investment, investors think RISK is being reduced. If this were true, there would be no problem. But equity exposure does not equal risk exposure and risk changes over time. Think in terms of two relatively recent example. The RISK of the S&P 500 pre-Tech Bubble with less that 10% technology exposure and in 2000 with technology representing over 30% the risk in the market, as represented by a 252 day moving average of S&P 500 SD, spiked to over 15% during the period. The recent financial crisis saw an even more dramatic shift in the risk of stocks and bonds as corporate spreads over treasuries ballooned in late 2008 early 2009 and the SD of the S&P 500 spiked to a mind blowing 60%! So for target date funds to imply that they are systematically reducing RISK exposure is misleading at best.

The remedy is Target Date Funds 3.0, an approach that maintains a consistent approach towards portfolio RISK. It is a systems solution as much as an investment solution but most importantly in the debate about full disclosure to clients, it provides an honest relationship between what investors understand they are getting and the marketing hype of the industry. For more information