The collapse of the financial markets has sounded a strong wake-up call for target date funds. While these funds did help to mitigate the impact of extreme volatility for those who invested in them, many still believe that the losses they sustained were nevertheless far greater than they should have been. Since more and more retirement plans are likely to offer target date funds as default options going forward, they need to be fixed if they are to live up to their name and their promise.
"Target date funds are a great idea but they need substantial improvement," says Ron Surz, president and CEO of San Clemente, California-based PPCA Inc., whose firm has developed benchmark indexes for target date funds. "People are saying that this market collapse is just a fluke, but even so, those who invested in target date funds should not have lost so much."
Surz believes target date funds performed far worse than expected during the worst of the crisis because they were not diversified enough; their asset selection was poor because they were too "inbred" and their glide paths–which suppose that an investor will remain in a fund even beyond its maturity date–have been poor. These characteristics have resulted in significant losses to most 2010 and 2015 funds–vehicles that should not have fallen as much as they did, Surz maintains. According to PPCA figures, investors in near-term, current, and 2010 funds have lost 12% and 25%, respectively, in just the past year, and those in longer-dated funds have lost more than 35%, thereby underperforming the firm's benchmarks significantly.
As they now stand, target date funds are also unable to address the numerous complexities that come about in the distribution phase of a person's life.
"Although it seems that everything crashed together, diversification actually did help in 2008," Surz says. "Target date funds need to diversify beyond just stocks and bonds. The inbreeding comes about because fund companies are using only homegrown products and not offering an open architecture and the glide path needs to end at the target date."
Experts like Andrew Scherer, managing director at Van Kampen Investments in Oakbrook Terrace, Illinois, also believe that target date funds need to evolve more, especially given the current economic and financial context. It is very important for a plan sponsor with a fiduciary responsibility to be mindful of the construction of the target date fund, Scherer says, "as in our view, some have a better asset allocation methodology than others." Van Kampen's target maturity fund, for instance, is different from others in that the asset allocation process is designed to ensure that a 401(k) participant has the necessary income in retirement to maintain their lifestyle. "This is an important consideration and because of this approach, we feel we have had a more appropriate allocation to equities than others," Scherer says.
Nevertheless–and notwithstanding the serious decline in the market–investors have by and large stuck with their investments, Scherer says, and target date funds have played a significant role here, as investors have maintained their investments and not responded to the markets in a knee-jerk fashion, he says.
