On June 16, 2010, the SEC proposed new rules for target date funds regarding how the funds should be named and marketed. Target date funds have grown in popularity over the past decade. A recent Fortune magazine article noted that, according to Hewitt Associates, about 58% of companies are automatically enrolling employees in 401(k) plans, a number that is expected to grow, and target-date funds are the most popular default investment. The same article stated that target date funds, which held $15 billion of assets in 2002, now hold $269 billion and are expected to hold $1 trillion of retirement savings in just four years, according to Cerulli Associates.
Target date funds are designed to allow investors to hold a diversified portfolio of assets that is rebalanced automatically among asset classes over time. As the target date approaches, a target date fund shifts its asset allocation in a manner that is intended to become more conservative. The schedule by which the fund's asset allocation is adjusted is referred to as the fund's "glide path." Usually the glide path reflects a decreased percentage in stocks as the target date approaches, and an increase in fixed income. At some point, the fund reaches a "landing point," at which time the asset allocation remains fixed.
However, target date fund managers take different approaches to balancing the variety of risks faced by individuals in the marketplace, and thus target date funds with the same retirement year often have different asset allocations. Moreover, some target date funds reach their landing point at or near the target date, while others reach the landing point a significant number of years after the target date.
The SEC noted that as a result of market losses in 2008 along with the increasing significance of target date funds in 401(k) plans, a number of concerns have arisen about how target date funds are named and marketed. Losses in 2008 in funds with a target date of 2010 varied between 9% and 41%. The SEC found that the key factor in this wide variation of losses was the use of different asset allocation models by different funds; i.e. funds with the same target date had significantly different degrees of exposure to volatile asset classes. The SEC acknowledged that this is a result of each fund having a different opinion on what the best "glide path" should be in terms of asset allocation and risk exposure. In the same way, the SEC noted that each investor's ideal "glide path" will depend on factors other than their retirement date including, but not limited to, risk tolerance, other investments, life expectancy, and savings rate.
The SEC found that the name of a target date fund can be cause for concern. Most target date fund names include the year of the target date. This year would presumably coincide with the year of the investor's retirement. However, an investor may not understand the significance of the target date, believing that at the target date their fund's assets will be invested more conservatively to provide a pool of assets for retirements needs. Moreover, they may believe that all funds that have the same date in their name are managed according to a similar asset allocation strategy.
Another area of concern noted by the SEC is the degree to which marketing materials provided to 401(k) participants and other other investors in target date funds may have contributed to a lack of understanding by investors of those funds and their associated investment strategies and risks. The SEC found that the simplicity of the messages in the marketing materials at times belied the fact that the asset allocation strategies among target date fund managers differed. The SEC noted that the appropriateness for an investment depends on not only an investor's retirement date, but also the investor's appetite for risk, other investments, retirement and labor income, expected longevity, and savings rate. In other words, the investor is relying on the fund manager's asset allocation model based only on the year of the target date, which may or may not be appropriate for the particular investor.
In order to remedy these investor concerns, the SEC proposed to amend rule 482 under the Securities Act and rule 34b-1 under the Investment Company Act that, if adopted, would require a target date fund that includes the target date in its name to disclose the fund's asset allocation at the target date immediately adjacent to the first use of the fund's name in the marketing materials. The proposed rule change would also require enhanced disclosure in marketing materials regarding the fund's glide path and asset allocation at the landing point, as well as the risks and considerations that are important when deciding whether to invest in a target date fund.
A complete copy of SEC Release No. 33-9126 can be found here.