Target fund rules may mean 401(k) changes

Newly proposed disclosure rules could steer plan sponsors to more conservative target date funds for their 401(k) plans, according to some industry experts.

The Securities and Exchange Commission this month proposed a series of rules that would require fund providers to be more explicit about a target date fund’s glide path — or how its asset allocation changes over time.

The new rules also would require marketing materials to state that a target date fund isn’t guaranteed and shouldn’t be selected solely on the basis of the investor’s age, tax bracket or expected retirement date.

Although the rules are meant to protect individual investors, industry experts predict that plan sponsors would be most affected, since they often choose target date funds as the default choice for participants in 401(k) and other retirement plans. Simplified disclosures, they argue, would push cautious plan sponsors to think twice about accepting the recommended funds of their record keeper or adviser.

“Plan sponsors may be more likely to go with conservative allocations,” said Lynette DeWitt, director of research at the Financial Research Corp., who added that the proposal has led to a rethinking of retirement-oriented investing among sponsors.

The rule proposal is the latest step in a multiagency effort led by the Labor Department and the SEC to enhance disclosure in 401(k) plans and to clarify who can provide advice to plan sponsors. Target date funds came under scrutiny following the 2008 downturn, when many funds with a 2010 target suffered steep losses as a result of their high exposure to stocks.

TEACHING INVESTORS

Although fund companies provide glide path details, the proposed rules would require marketing materials to include:

• A label alongside the fund’s name that details its asset allocation.

• A table, chart or graph to depict the glide path and to detail the fund’s projected asset allocations.

• A statement explaining that the allocation changes over time and indicating the point during the post-target-date period at which the allocation becomes final.

Experts said the new disclosures might encourage sponsors to lean toward the “to” funds — or those funds that switch to conservative allocations earlier to meet a final goal at the investor’s retirement date — over “through” funds, which stay allocated to equities longer because their glide path extends as far as 25 years beyond the target.

“In general, I think that if people are buying a target date fund after 2010, then they want it to be conservative. Once the disclosure of the glide path is a reality, more likely than not people will vote with their dollars, and the dollars will go “to’ retirement,” said Marcia Wagner, managing director of The Wagner Law Group.

“You should expect increased questions from plan sponsors,” said Michael J. Francis, president of Francis Investment Counsel LLC, which has $4.4 billion in assets under advisement. “They’ll want to see a side-by-side comparison of funds that manage to retirement and those that manage through retirement.”

NOWHERE “TO’ GO

Switching to a “to” fund is easier said than done. “People haven’t switched because there’s precious little to choose from on the “to’ side,” Mr. Francis said.

Others think that savvy plan sponsors, feeling pressure from the SEC and the Labor Department, may gravitate toward customized target date funds or other products.

The increased scrutiny “will likely raise questions about fees and whether single managers should be doing everything for a large plan,” said Thomas J. Fontaine, global head of defined contribution at AllianceBernstein Investments Inc. “We think there will be increased demand for customized strategies.”

Tim Wood, an adviser with Deschutes Investment Advisors Inc., predicted that fund companies will develop two lines of target date funds. “You’ll have the traditional 2030 fund and then the “I’m completely done’ 2030 fund,” he said.

Sure enough, John Hancock Funds LLC has filed a series of “to” retirement funds, and others, such as DWS Investments Inc., offer funds with multiple glide paths.

Still, not everyone thinks that the proposed rules will change the landscape dramatically.

“I wouldn’t be surprised to see some series making adjustments based on feedback from fiduciaries, but I don’t know whether we’ll see a wholesale shift away from the more aggressive glide path just because of the disclosure piece,” said Laura Lutton, an analyst for Morningstar Inc.

For instance, DWS Investments has slotted an alternative asset allocation fund into its target date funds, a strategy that Doug Beck, head of product management, thinks will appeal to plan sponsors who are worried about risk.

E-mail Darla Mercado at [email protected].