Despite the controversy around target date fund managers' pushing their own products, target date funds that are composed of only proprietary portfolios perform better than open-architecture target date funds.
Five of the seven top-performing target date funds are composed of only proprietary funds, according to a report released today by Morningstar Inc. “There is no compelling reason to choose open-architecture target date funds over closed-architecture target date funds,” said Morningstar Inc. analyst Laura Lutton, who wrote the report.
The findings are particularly surprising given that, for the past several months, lawmakers and regulators have been holding hearings on whether there is an inherent conflict of interest in target date funds that offer only proprietary portfolios.
In October, the Senate Special Committee on Aging held hearings on the matter. Sen. Herb Kohl, D-Wis., chairman of the committee, is planning to unveil legislation that would require target date funds — and perhaps all managers of qualified default investment alternatives in defined-contribution plans — to act as fiduciaries under the Employee Retirement Income Security Act of 1974. Under Sen. Kohl's plan, that requirement would kick in by the end of April.
The top performing target date fund series are managed by MFS Investment Management, American Century Investments, and Wells Fargo Funds Management LLC. The other top performers: the fund series managed by ICMA-RC, J.P. Morgan Funds,
The Vanguard Group Inc. and Capital Research & Management Co.
Of those, only the target date fund series managed by ICMA-RC and Wells Fargo are open.
The majority of low-performing target date funds were composed of a mix of proprietary and outside mutual funds, according to the report. Of the seven lowest-performing target date fund series cited in the report, four were mixed and three were closed. Among the worst-performing mixed series are those managed by Massachusetts Mutual Life Insurance Co., John Hancock Funds LLC, ING Investment Management and Principal Funds Inc.
Critics of target date funds contend that performance isn't the only reason to choose one target date fund over the other. “It's not just about the outcomes, it's about how you get there,” said Michael Case Smith, head of institutional strategies at Avatar Associates LLC, an independent investment manager, who has testified about the embedded conflict of interest issues with target date funds. “What we are talking about is removing those conflicts of interest.”
And in fact, Morningstar in its report urged better disclosure among target date fund managers. Among its recommendations, the research firm suggested that these managers better disclose the investment rationale behind their glide paths; disclose the subasset classes represented within the glide path and provide better details about asset allocation. Among the top-20 target date funds, none provide such disclosures, according to the report.
“Unless regulators force the issue,” said Ms. Lutton, “it won't happen.”
