Target date funds must earn the trust of retirement industry

While last year’s unpredictable performance may not mean the end of target date funds, it did signal coming changes that could affect how they are structured and sold in the future.

In fact, many firms already modified the investments held in the funds, and lawmakers and regulators are eyeing changes in disclosure.

Target date funds, designed to be a one-stop retirement solution, use a mix of stock and bond allocations that shift over time, becoming more conservative as the strategy approaches a specific date.

Last year, target 2010 funds, which were held by investors closest to retirement, held vastly different asset allocations and demonstrated a wide disparity in performance, despite having the same target date.

On average, the 2010 target date funds lost 23% last year, according to Morningstar Inc.

The losses ranged from as low as 11% to as much as 41%, the firm found, while the S&P 500 lost about 38%.

“There was a disparity in performance and part of that depended on asset allocation,” said Laura Lutton, editorial director at Morningstar.

Even though they took a battering last year, target date funds are a growth area for the fund industry. Assets stood at $210 billion as of Aug. 31, up from $41 billion in 2004, Morningstar found.

And the funds saw significant growth through the crisis.

In 2008, there were $56.8 billion in net inflows into target date funds, representing 49% of total mutual fund flows.

This year through July 31, the funds had already captured $35 billion in net inflows, representing 14% of total mutual fund flows for that time period.

One reason for the sales is that the funds are considered a qualified-default-investment option in defined-contribution plans.

“By virtue of them being included in defined-contribution plans made those assets a lot stickier,” Ms. Lutton said. “As long as they are allowed as the default in defined-contribution plans, we will continue to see assets go there.”

Still, observers believe that change in the way the funds are structured and regulated is inevitable.

“I think you’ll see more disclosure around the funds,” Ms. Lutton said. “The disclosure among the funds is terrible.

Sen. Herb Kohl, chairman of the Senate Special Committee on Aging, is leading the charge on Capitol Hill. He orchestrated a joint hearing in June by the Securities and Exchange Commission and the Department of Labor.

The Wisconsin Democrat’s staff plans to call a meeting with the SEC and Labor Department staffs this month if the agencies have not presented any proposals, according to a staff member.

Some changes are already at work, driven by the industry.

In June, Great-West Retirement Services, a unit of Great-West Life Assurance Co., launched a series of target date funds that offer risk tolerance options and open architecture.

And Putnam Investments and Fidelity Investments have announced changes to their target date investment strategies in recent weeks.