Shareholder Alert: SEC TO Examine Target Date Funds and 12b-1 Fees

As this Web site has noted before, target-date funds have failed to deliver on their implied promise of delivering above-average returns through carefully designed portfolio diversification.

At best, some of these wildly-popular funds often are nothing more than marketing gimmicks which bundle together poorly or average-performing funds, complete with high fees, from a single fund family into a single target-date fund.

In short, too many target-date funds are used as asset gathering magnets as opposed to being carefully-designed risk management portfolios.

Worse, the amount of thought which goes into the "glide path," or how the risk exposure is measured through time, is often incomplete.

So within only a few years of their introduction, their poor investment returns have become so widely known that they have attracted the attention of the SEC.

One major problem for target date funds is the design of their "glide path." This is the risk exposure which is supposed to become more conservative as the end year approaches and the shareholder moves closer to retirement. But there is a wide difference in how these glide paths are constructed or even envisioned.

For example, when I asked a target date portfolio manager what would happen to a fund's asset allocation exposure when it reached the maturity year, there was a silence on the phone. He then said "we'll cross that bridge when we come to it," and then said whether the fund went into T-bills, or retained its last asset allocation exposure had not been determined. This indefinite position was not conveyed to shareholders in any of the fund's promotional literature.

Maybe the SEC can correct problems associated with target date funds and 12b-1 fees before shareholders suffer any more significant financial damage.

What follows is a portion of the testimony to the Subcommittee on Financial Service and General Government, June 2, 2009. This comes from the SEC Web site. Testimony of Mary Schapiro, SEC Chairwoman.


A Portion of Schapiro's Testimony on Target-Date Funds

"In addition, on June 18, the SEC and the Department of Labor will hold a joint hearing on target date funds. Target date funds and other similar investment option. Target date funds and other similar investment options are investment products that allocate their investments among various asset classes and automatically shift that allocation to more conservative investments as a "target" date approaches. These funds have become quite popular, and growth in target date fund assets is likely to continue since these funds can be default investments in 401(k) retirement plans under the Pension Protection Act of 2006. However, target date funds have produced some troubling investment results. The average loss in 2008 among 31 funds with a 2010 retirement date was almost 25 percent. In addition, varying strategies among these funds produced widely varying results. Returns of 2010 target date funds ranged from minus 3.6 percent to minus 41 percent.

"These returns cause concern for investors and regulators alike. I can assure you that SEC staff is closely reviewing target date funds' disclosure about their asset allocations. In addition, in connection with our joint hearing with the Department of Labor, we will consider whether additional measures are needed to better align target date funds' asset allocations with investor expectations. Among other issues, we will consider whether the use of a particular target date in a fund's name may be misleading or confusing to investors and whether there are additional controls the SEC should impose to govern the use of a target date in a fund's name.

On 12b-1 Fees
"I also have asked the staff to prepare a recommendation on rule 12b-1, which permits mutual funds to use fund assets to compensate broker-dealers and other intermediaries for distribution and servicing expenses. These fees, with their bureaucratic sounding name and sometimes unclear purpose, are not well understood by investors. Yet in 2008, rule 12b-1 was used to collect over $13 billion in investors' funds out of fund assets. It is essential, therefore, that the SEC engage in a comprehensive re-examination of rule 12b-1 and the fees collected pursuant to the rule. If issues relating to these fees undermine investor interests, then we at the SEC have an obligation to step in and adjust our regulations."