The “To-Through” Target Date Fund Distinction Uses A Wacky Definition Of “To.” What Is “Is”?

Monday, July 30, 2012 13:21
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The “To-Through” Target Date Fund Distinction Uses A Wacky Definition Of “To.” What Is “Is”?

Tags: investment strategies | retirement income | retirement planning | target date funds

Target date fund (TDF) assets are rapidly approaching $1 trillion, including mutual funds, collective investment funds, and customized solutions. Most of the terms used to differentiate among the various offerings don’t really matter, and one distinction in particular is just plain misleading, namely “to” vs. “through.” Other distinctions without an important difference include open-closed, active-passive, ETF-mutual funds, etc.

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The rapid growth in TDFs is a direct result of the Pension Protection Act (PPA) of 2006, which established three Qualified Default Investment Alternatives (QDIAs) for participants who do not make investment elections. TDFs are the most popular choice of QDIA, despite their deficiencies.
 
Even though TDFs existed prior to the PPA, the proliferation of product is only five years new, so there’s still a lot of room for improvement. One important lesson was learned in 2008 when the typical 2010 fund lost 25%, leading to joint hearings with the Securities and Exchange Commission and Department of Labor in June 2009.
 
The words “to” and “through” were coined at these hearings. The testifying fund companies explained that they take substantial risk at the target date because their glide paths serve “through” the target date to death. This is in contrast to funds called “to” funds that end at the target date. The clear implication is that “to” funds are far less risky at the target date than “through” funds, but this is not true because the industry has elected to define “to” in a bizarre way, much like President Clinton defined “is.” “To” is being defined as a flat equity allocation beyond the target date. This is unfortunate because the very essence of “to” is the non-existence of “beyond.”
 
The words “to and “through” were used at the target date fund hearings to mean:
  • Through: Target date is a speed bump in the highway of life.
  • To: Target date is the end of the investment mission. Accumulation only.
 
Accordingly, the common belief is that “to” funds hold less equity at the target date because they end there, as shown in the graph on the right.
But “to” funds are being defined as any fund with a flat equity allocation beyond the target date. Why does allocation beyond the target date matter if the intention is to end at that date? The trick is appearing to end without really ending.
 
The pretext is that any fund that reaches its lowest equity allocation at target date is a “to” fund because changes in the glide path have ended, even though the fund continues on. Fund companies want to keep assets as long as possible, despite emerging investor interest in “to” funds. Fiduciaries believe a “to” fund is safer and more prudent, and it should be. “To” should be safer than “through,” but it might not be, as shown in the graph below.
 
 
As a practical matter, the to-through distinction is moot when one considers participant behavior. Most defaulted participants withdraw their accounts at retirement, so most TDFs are de facto “to” funds. The problem is that most are too risky at the target date, even so-called “to” funds. Unfortunately, little has changed since the 2008 debacle, so participants remain exposed to substantial loss as they near retirement. For more on TDFs, visit Target Date Solutions.
 
Caveat emptor. There will be a repeat of 2008, and this time class action loss-suits are inevitable. Justice will prevail. Attorneys will ask fiduciaries to describe the remedial actions they have taken in their TDF investments to protect participants from a repeat of 2008. Ignoring the past and hoping it’s different the next time is not an option, and it’s certainly not an enlightened view of risk management.
 
How will you respond?

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