Mind the Approach
A topic for retirement planning chatter is the Siegel+Gale survey results (Investor Testing of Target Date Retirement Fund Comprehension and Communications) of investors' understanding of what exactly they purchased when investing in target date mutual funds. The study was sponsored by the Securities and Exchange Commission (SEC) and conducted by Siegel+Gale, a market research firm.
The punch line — to the media's evident surprise — is investors do not really comprehend the target date concept; nor do current disclosure standards adequately communicate the idiosyncrasies of the product. We will not go as far as to say the results were obvious, but we will state the study started with the wrong premise. Perhaps its starting point should have been, Why would anyone not be confused, given the gross disparities between funds classified in the same categories?
We view the target date market as a collection of idiosyncratic mutual fund offerings with little in common save the mention of a target year in the fund's name. Opacity is not dispelled by the mutual fund rating agencies. For the most part they do little or nothing to group like with like; instead, they rely heavily on the year in the name to categorize funds.
The problem is not every target date 2020 (2025, 2030 or 2035 and so on) fund is fungible for another. Offerings within a category are not commodities. Yet categorization methods treat them as such. The confusion is compounded by a failure to consider or to incorporate the critical dimensions which might actually help the end investor.
Consider current equity allocations for funds in the 2015 target date category. The median allocation is 47 percent; but those in the top quartile have equity holdings exceeding 53 percent. If the whole point is to progressively nudge the allocation of risky assets (such as equities) lower as the target date approaches, half of the funds in the 2015 category fail this simple prudence test. Most readers, we are certain, would generally avoid recommending a 50 percent plus allocation to risky assets with less than three years left on the horizon clock.
Risk-class asset allocation funds offer a yardstick for comparison. The median equity allocation for funds classified by Lipper as Conservative Mixed Target Asset Allocation funds (balanced) is just shy of 30 percent — a 17 point difference versus the median for the 2015 target date category. Many of the same fund families with an offering in the target date 2015 category are represented as well within the conservative allocation category. What accounts for the marked difference? Lipper uses specific equity weights to classify risk class allocation funds as either Conservative, Moderate or Growth. Similar criteria are absent for target date funds. Now to be fair to Lipper, many of its competitors have similar policies.
So for all of the kerfuffle attendant the SEC's insistence on showing investors the glide path (the shift in the fund's asset allocation as the target date draws near) in the prospectus, few seem to use it to categorize funds. Nor has there been a concerted effort to build adherence to the glide path into a fund's ranking or rating. No one offers a five "North Star" award to a target date fund for cleaving to its glide path, bringing its investors in for a gentle landing.
Alas, old habits die hard. Rankings are based solely on performance: no regard is given to the fact a number of funds, particularly in the near term target date categories, have equity allocations that defy any prudential measure. More rigorous standards are needed; especially if a target date fund family is used as the qualified default investment alternative (QDIA) in a defined contribution or 401(k) plan. Since the Siegel+Gale study suggests this is the channel by which the vast majority of individuals invest in target date funds, glide path suitability and adherence are not just theoretical issues. Otherwise, buckle up, you may be in for a turbulent landing.
Analysis based on Lipper mutual fund category definitions.
Equity allocations based on the latest holdings for the primary share class (as determined by Lipper) reported as of Mar 31, 2012. Different fund companies have different reporting schedules; allocation percentages may thus based on different dates on or before Mar 31, 2012.
(Source: Lipper; AIFS estimates.)
About American Independence Financial Services, LLC
American Independence Financial Services, LLC ("AIFS") is the investment adviser and administrator for the American Independence Funds and the NestEgg Target Date Funds. The firm is a limited liability company founded in 2004.
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