Why Target-Date Funds Fail

Advisor Perspectives published an article Tuesday entitled “Why Target-date Funds Fail” by the editor, Robert Huebscher, that concurs with the findings of a 2010 paper, “Agency Problems in Target-Date Funds,” by Vallapuzha Sandhya, written as part of her doctoral dissertation at Georgia State University.


As Huebscher explains, an “agency problem” in economics is a mismatch of incentives in a transaction between the principal (in this case, the investor) and the agent (in this case, the fund company): The agent is able to profit at the principal’s expense.


I agree this is at the root of the problems with target-date funds (TDFs), and would add the following observations:


1. Until and if TDFs are vetted, agency problems will persist, and participants will be exposed to excessive risk at the target date. Plan sponsors and their advisors are enabling failure. Procedural prudence is not enough in this case.


2. To package product, fund companies are selling “objectives” that are actually hopes – hopes that can be served by any glide path they choose, since any glide path will do. Replacing pay and managing longevity risk are hopes. An objective with a nonsensical course of action is a hope. The right course of action is saving more.


This packaging is plain for all to see in two ways: The equity allocations of equity managers are generally higher than those of bond managers, and prospectuses and fact sheets NEVER state objectives that are used in sales. Instead the “official” objectives are the likes of “Earn a return commensurate with the risk.”


3. If and when fiduciaries wake up, which could take a lawsuit, they will demand a real objective, like bring the participant safely to the target date with appreciated savings intact. That would be a fund with a real “to” date (i.e., equity allocations actually end at the target date, when assets are moved entirely into distribution-type vehicles) rather than the phony baloney versions currently being served up.


I would welcome your comments.

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