TDFs May Give Clients a False Sense of Security
As target-date funds get ever cheaper and more popular, regulators — and some advisors — worry that investors may be too complacent about their safety. FAs who work with retirement plans praise their simplicity and ease of use. But critics warn that their set-it-and-forget-it strategy comes with risk, and experts say advisors should make sure clients don’t make unwarranted assumptions.
Total assets in TDFs have grown tenfold since 2005 to roughly $703 billion, according to Morningstar data. Cerulli says the funds could account for nearly 90% of all new 401(k) contributions within five years. Meanwhile, as FA-IQ’s sister publication Ignites has reported, expenses have fallen by 7% since 2013 to an average asset-weighted fee of 78 basis points.
Yet the SEC is concerned that investors — and even industry professionals — ignore the details of individual TDFs at their peril. In a February speech, Commissioner Luis Aguilar called for better disclosure of how the funds work. Alarmingly, nearly two-thirds of investors the SEC surveyed in 2012 thought TDFs guarantee income in retirement. More than half thought funds with the same date have similar asset allocations. “It is imperative that investors better understand the risks presented by target-date funds,” Aguilar said.
Advisors are worried, too. Murray Carter, EVP for wealth management at CSG Capital Partners of Janney Montgomery Scott in Washington, D.C., fears the long-running bull market has pushed TDFs into taking too much equity risk — a move that could spell trouble later. Funds with conservative allocations have come under pressure for underperforming, Carter says, so some have become more aggressive. “Is that opening [investors] up to more risk should — or when — the market rolls over?” he asks.
Target-date funds are not as simple as they appear to many retirement-plan participants, warns Carter, whose group has roughly $500 million in AUM. The only thing the funds really have in common is their time-based approach to asset allocation. Two similarly dated TDFs from different providers may have different strategies, whose nuances may not be readily apparent to investors. “The onus is on the investment committee and the plan sponsor to know why [a fund] is suitable for their work force,” says Carter — and the onus is on the plan advisor to educate them.
Financial advisors who don’t work with retirement-plan sponsors often avoid TDFs because they consider the funds too generic to meet individual clients’ needs. Age is always a factor in determining asset allocation, but it’s not the only one, says Karen Blodgett, a principal at Aspiriant in San Francisco. “We implement a client’s asset allocation … at the portfolio level, not the account level,” says Blodgett, whose firm has AUM of $8 billion. That is, the glide-path approach may be fine in certain parts of a client’s financial plan but inappropriate in others.
For example, TDFs’ time-based strategy might be useful in a 529 college savings program. “The rationale behind an asset allocation in a 529 plan doesn’t have nearly as many factors as building an asset allocation for a client’s overall portfolio to support all their financial goals and objectives,” says Blodgett.
As a DC plan advisor, Jason Chepenik sees TDFs as a powerful weapon in combating what he considers the most formidable obstacle to successful retirement planning: low savings rates. TDFs reduce the initial fear of investing, says Chepenik, managing partner of Chepenik Financial in Winter Park, Fla., which has AUM of around $850 million. By eliminating the need for complex decision-making, TDFs make it easier for participants to start saving, especially if they are young. “If I can get them to focus on what’s most important and take away the anxiety of picking an investment fund, it’s made my job so much easier,” he says.
Chepenik adds that TDFs can help to take the emotion out of investing in a way a large menu of different funds can’t. Plan participants — especially rookie investors — tend to move their savings around from one fund to another as the markets seesaw. Often, they make poor decisions. “But when it’s all blended together into one thing, they don’t see the good, the bad and the ugly,” he says.
That’s exactly the problem, says Ron Surz, president of San Clemente, Calif.-based Target Date Solutions. Because names of TDF funds say little about their asset allocation or glide path, investors close to retirement can get blindsided by big losses in a market downturn because they are more exposed to equities than they thought. For example, people in 2010 target-date funds lost an average of 30% in 2008-09. Surz, who runs his own target-date fund, thinks many of his competitors could be facing a fiduciary catastrophe. After the next market slump, he predicts, “There will be lawsuits.”