Target Date Funds (TDFs) have three interest groups: investment managers, fiduciaries, and beneficiaries. The interests of these three groups are not aligned, but the new DOL fiduciary rules could change that.
Beneficiaries will be the losers in the next market correction because of these misalignments.
Investment managers create TDFs for profit, which is, after all, their business. Fiduciaries choose TDFs, presumably for the benefit of participants, but that’s not what is happening. Beneficiaries want to be protected, especially as they enter retirement, but they are actually exposed to substantial risk. In the following we discuss the interests of each of these groups with the intention of moving those interests toward better serving beneficiaries.
Updated Fiduciary Rule
The DOL’s Fiduciary Rule becomes effective this September:
“These new rules update regulations created nearly a half-century ago that simply are not providing the protections America’s workers need and deserve for their retirement savings so that they can retire with dignity,” said Assistant Secretary for Employee Benefits Security Lisa M. Gomez. “The investment landscape has changed, the retirement landscape has changed, and it is critical that our regulations are responsive to those changes so that workers can reach the secure retirement that they work for decades to finally achieve.”
These updated rules apply to target date funds (TDFs), the largest Qualified Default Investment Alternative (QDIA). The rules clearly apply to fiduciaries—primarily investment advisors—who are conflicted by procedural prudence that obligates them to choose an oligopoly which is motivated by profit rather than prudence. Investment managers might not be fiduciaries since they are merely providing products; they are conflicted, but possibly not covered by the rules.
Investment Managers
Investment managers have seized upon the TDF opportunity to package product, populating glide paths with proprietary funds. The major misalignment with beneficiary best interests is at the target date, where the typical TDF is 85% in risky equities and long-term bonds, an allocation that lost more than 30% in 2008. It’s shocking that the theory they say they use is 80% risk-free at the target date—much safer than the 85% risky in actual practice.
Participants bear risk, not fund companies who get paid a premium for higher risk regardless of the outcome. Surveys report that participants want to be protected as they near retirement, and they think they are. Allocations at the target date are the most important because assets are likely to peak at that date, creating Sequence of Return risk. Management fees for equities and bonds are higher than those for safe Treasury bills. Risk also wins the performance horserace, until it doesn’t.
Investment managers sell this risky allocation as the solution to inadequate savings. Growth trumps safety because participants have not saved enough. Read more on this in the Human Face of TDFs.
Fiduciaries
Fiduciaries, namely plan advisors and trustees, want to protect themselves against lawsuits and believe that (1) any Qualified Default Investment Alternative (QDIA) will do, and (2) you can’t go wrong with the Big 3 Oligopoly—Vanguard, Fidelity, and T. Rowe Price—because everyone else is using them. This is a breach of the Duty of Care that, like our duty to protect our children, holds fiduciaries responsible for harm to our dependents that should have been prevented. Fiduciaries are duty bound to seek the best TDFs for their beneficiaries, but this is not happening. The next market correction could bring lawsuits that remedy this imprudent practice. Substantive prudence should prevail over procedural prudence.
Beneficiaries
Beneficiaries want to be protected as they enter retirement, and may think they are, but they are not.
The fact is that most TDFs are riskier today than they were in 2008, when they lost more than 30%. The TDF industry is also 18 times bigger at $3.5 trillion today versus $200 billion in 2008.
Conclusion
Because of disparate interests, there are winners and losers and chumps in TDFs. Investment managers are winning big time since $3.5 trillion has poured into TDFs in just the past decade. Beneficiaries will be the big losers in the next market correction, but this could be avoided if they take back control of their retirement savings by using personalized target date accounts.
SEE ALSO:
• Capitol Hill Fiduciary Rule Reaction: Praise and Ridicule
• Fiduciary Rule Reaction: For and Against
• Target Date Plus Added as QDIA Option for Voya Retirement Plans