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."
Sunday, June 7, 2009
Friday, June 5, 2009
Meet the Four Hoursemen of the Retirement Apocolypse: Income Growth, Housing, Jobs, Fund Fees
Investors in 2009 should clearly see the linkage between the decreases in home prices, income, portfolio returns, job growth, and the importance of fees charged to manage your mutual funds.
In a low-growth economy, and in the beginning of a economic scenario which will see a jobless recovery, these critical engines of wealth growth are all working on one cylinder. These returns are then dragged down further by high expenses on your investment portfolios.
If you factor in the losses in housing and portfolios, a decline of about 30% in each, you can get a good idea of why investors should be concerned about every penny they can earn and save.
While there losses have frequently been discussed, not much has been written about the time it will take for investors to recover their biggest losses--in investment portfolios and house prices. Time is a significant element in any financial planning discussion since it deals with the time value of money. For starters, I bet that the current severe recession, caused by the decline in the housing market and incredible consumer debt loads, have combined to wipe out about a decade of economic prosperity.
A decade is half a generation. The slow economy, job losses, investment returns, declines in savings and wage growth rates all come with a price. The best example is in the backlog of housing. The economic research firm ISI estimated that in Florida alone there is about a seven year backlog of real estate inventory. That means too much supply and lower prices in a buyer's market for seven years.
Re-Thinking Real Estate
With national home prices off by a painful 32% from their 2006 peaks, many people should rightly question the role of real estate as a long-term investment and as an engine to fund retirement.
According to a report. any increase in housing prices will be tied to a rise in wage growth. Even when this occurs, the reports by Moody's notes that housing appreciation will be faster in less populated parts of the nation.
With unemployment at record levels, getting a job is a significant problem, let alone seeing any wage growth. Of course, getting a job will see a significant percentage increase in wage growth, but those wages would be used to repair a household's balance sheet first before they can be evident in an savings.
As I noted in my white paper, As a result of the current housing market bubble, any new housing cycle correction could take over 20 years to reach an equilibrium state where buyers and sellers are proportional.
The reason: When baby boomers aged 65 to 75 begin to sell their houses, there will be three sellers for every buyer. This will create a “generational housing bubble” on top of the speculative housing bubble that developed from 2005 to 2007. This shift (more sellers than buyers) could start as early as 2010 and last until 2030. In the past, without this major change in demographics, housing corrections historically lasted three to seven years.
This new generational housing bubble would differ on a state-by-state basis as the number of older homeowners declines relative to younger home buyers, but its overall impact will be the same: there will be too many sellers to sustain house price increases.
Since real estate has been one key driver of retirement wealth (the other is portfolio returns in IRAs, 401(k)s, any disruption of the housing market will have a profound effect on retirement planning.
--Chuck Epsstein
cepstein@prodigy.net
In a low-growth economy, and in the beginning of a economic scenario which will see a jobless recovery, these critical engines of wealth growth are all working on one cylinder. These returns are then dragged down further by high expenses on your investment portfolios.
If you factor in the losses in housing and portfolios, a decline of about 30% in each, you can get a good idea of why investors should be concerned about every penny they can earn and save.
While there losses have frequently been discussed, not much has been written about the time it will take for investors to recover their biggest losses--in investment portfolios and house prices. Time is a significant element in any financial planning discussion since it deals with the time value of money. For starters, I bet that the current severe recession, caused by the decline in the housing market and incredible consumer debt loads, have combined to wipe out about a decade of economic prosperity.
A decade is half a generation. The slow economy, job losses, investment returns, declines in savings and wage growth rates all come with a price. The best example is in the backlog of housing. The economic research firm ISI estimated that in Florida alone there is about a seven year backlog of real estate inventory. That means too much supply and lower prices in a buyer's market for seven years.
Re-Thinking Real Estate
With national home prices off by a painful 32% from their 2006 peaks, many people should rightly question the role of real estate as a long-term investment and as an engine to fund retirement.
According to a report. any increase in housing prices will be tied to a rise in wage growth. Even when this occurs, the reports by Moody's notes that housing appreciation will be faster in less populated parts of the nation.
With unemployment at record levels, getting a job is a significant problem, let alone seeing any wage growth. Of course, getting a job will see a significant percentage increase in wage growth, but those wages would be used to repair a household's balance sheet first before they can be evident in an savings.
As I noted in my white paper, As a result of the current housing market bubble, any new housing cycle correction could take over 20 years to reach an equilibrium state where buyers and sellers are proportional.
The reason: When baby boomers aged 65 to 75 begin to sell their houses, there will be three sellers for every buyer. This will create a “generational housing bubble” on top of the speculative housing bubble that developed from 2005 to 2007. This shift (more sellers than buyers) could start as early as 2010 and last until 2030. In the past, without this major change in demographics, housing corrections historically lasted three to seven years.
This new generational housing bubble would differ on a state-by-state basis as the number of older homeowners declines relative to younger home buyers, but its overall impact will be the same: there will be too many sellers to sustain house price increases.
Since real estate has been one key driver of retirement wealth (the other is portfolio returns in IRAs, 401(k)s, any disruption of the housing market will have a profound effect on retirement planning.
--Chuck Epsstein
cepstein@prodigy.net
Thursday, June 4, 2009
How much can I charge thee? Let me count the ways.
Elizabeth Barrett Browning wrote: "How do I love thee? Let me count the ways."
But in the mutual fund business, some people ask: "How much can I charge thee. Let me count the ways."
There are many smart people in the mutual fund business who spent much of their work day working on schemes to separate investors from their investments. This includes excessive fees, kickbacks, and exotic ways to funnel money back to financial professionals and fund management
Kickback Schemes
Take the case of a mutual fund record keeper named BISYS.
In an SEC investigation from 2007, BISYS Fund Services settled a case with the SEC regarding certain side agreements with fund advisers. The mutual fund advisers involved in the settlement included AmSouth Bank (now part of Regions) and its two advisor subsidiaries, AmSouth Investment Management Company and AmSouth Asset Management. In this case, BISYS performed administrative functions for the mutual fund advisers.
The case is notable since it shows the lengths a very few mutual fund professionals will go to to keep and retain business using any means available. The problem is that even though only a few people resort to these illegal acts, they invariably affect thousands of individual shareholders.
According to the SEC, BISYS entered into undisclosed, side agreements in which BISYS agreed to kick back a portion of its administration fee to the fund advisers in exchange for their promise to continue recommending BISYS as an administrator to the funds' boards of trustees.
When these undisclosed side deals were completed, BISYS paid for the adviser's marketing, and some unrelated marketing expenses to promote the funds. As one would expect, this agreement should have been disclosed to the fund trustees and the shareholders, but it was not, according to the SEC. Of course, this is not surpising since who would voluntarily disclose an under-the-table kickback scheme?
In the enforcement action, the SEC forced BISYS to reimburse over $20 million dollars to fund shareholders at 28 firms, most of which the SEC did not identify. The $20 million is composed of more than $9 million in disgorgement funds (money already paid out by BISYS) and a $10 million penalty. From 1999 to 2004, BISYS provided over $230 million from its administration fees for the benefit of the funds' advisers or third parties pursuant to these side agreements, the SEC said.
Did the Kickback Scheme Affect You?
So the questions for shareholders is: Do you know if your mutual fund company was involved in this scheme and were you ever notified of this kickback scheme and how it affected you?
This case also shows that the mutual fund business is so commoditized that a fund company record keeper would resort to bribes to keep their business. In more competitive industries, other competing suppliers would introduce new innovations or compete on price to become more competitive and win the business.
This story leaves out two key questions:
1. How did BISYS define and sudsidize "marketing expenses"?
2. How much did this bribery scheme cost shareholders. In any society worldwide, the entire population pays a price for corruption. This is even more egregious when the bribery scheme is being used to defraud investors of their retirement or college education funds.
But in the mutual fund business, some people ask: "How much can I charge thee. Let me count the ways."
There are many smart people in the mutual fund business who spent much of their work day working on schemes to separate investors from their investments. This includes excessive fees, kickbacks, and exotic ways to funnel money back to financial professionals and fund management
Kickback Schemes
Take the case of a mutual fund record keeper named BISYS.
In an SEC investigation from 2007, BISYS Fund Services settled a case with the SEC regarding certain side agreements with fund advisers. The mutual fund advisers involved in the settlement included AmSouth Bank (now part of Regions) and its two advisor subsidiaries, AmSouth Investment Management Company and AmSouth Asset Management. In this case, BISYS performed administrative functions for the mutual fund advisers.
The case is notable since it shows the lengths a very few mutual fund professionals will go to to keep and retain business using any means available. The problem is that even though only a few people resort to these illegal acts, they invariably affect thousands of individual shareholders.
According to the SEC, BISYS entered into undisclosed, side agreements in which BISYS agreed to kick back a portion of its administration fee to the fund advisers in exchange for their promise to continue recommending BISYS as an administrator to the funds' boards of trustees.
When these undisclosed side deals were completed, BISYS paid for the adviser's marketing, and some unrelated marketing expenses to promote the funds. As one would expect, this agreement should have been disclosed to the fund trustees and the shareholders, but it was not, according to the SEC. Of course, this is not surpising since who would voluntarily disclose an under-the-table kickback scheme?
In the enforcement action, the SEC forced BISYS to reimburse over $20 million dollars to fund shareholders at 28 firms, most of which the SEC did not identify. The $20 million is composed of more than $9 million in disgorgement funds (money already paid out by BISYS) and a $10 million penalty. From 1999 to 2004, BISYS provided over $230 million from its administration fees for the benefit of the funds' advisers or third parties pursuant to these side agreements, the SEC said.
Did the Kickback Scheme Affect You?
So the questions for shareholders is: Do you know if your mutual fund company was involved in this scheme and were you ever notified of this kickback scheme and how it affected you?
This case also shows that the mutual fund business is so commoditized that a fund company record keeper would resort to bribes to keep their business. In more competitive industries, other competing suppliers would introduce new innovations or compete on price to become more competitive and win the business.
This story leaves out two key questions:
1. How did BISYS define and sudsidize "marketing expenses"?
2. How much did this bribery scheme cost shareholders. In any society worldwide, the entire population pays a price for corruption. This is even more egregious when the bribery scheme is being used to defraud investors of their retirement or college education funds.
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