Jim Lauder rebuts RIABiz article on the failure of target date funds

Good points, but some slaps in the face may be what it takes to get the consulting community to wake up. Class action lawsuits are a real possibility when we see the next 2008.

“I ask them to think about the person who has been in the call center or on the factory floor for the last 30 years…How much risk should an employer be willing to expose them to in the last 12 months before retirement?”

Then he takes a show of hands, asking if people would be willing to expose them to a 1 percent decline. Lots of hands. Five percent? Many hands fall. “I’ve had maybe one hand still up after a 10 percent loss,” he said.

Source: New York Times, June 15, 2012.

There is something wrong when that’s the view of employers AND target date funds were down as much as 40% in the year before the 2010 target date.

Brilliant Robert !!

The effectiveness of TD funds is an empirical question – what does the data say? Independent data, of course.

Other wise we’re just swapping opinions and stories.

Remember the Alamo (2008). Other than that, I’ll not be jousting with you Elmer.

“Target date funds that were close to reaching their target date suffered significant losses in 2008, and there was a wide variation in returns among target date funds with the same target date. Investment losses for funds with a target date of 2010 averaged nearly 24% in 2008, ranging between approximately 9% and 41% (compared to losses for the Standard & Poor’s 500 Index (‘‘S&P 500’’), the Nasdaq Composite Index (‘‘Nasdaq Composite’’), and the Wilshire 5000 Total Market Index (‘‘Wilshire 5000’’) of approximately 37%, 41%, and 37%, respectively)”

Source: Security and Exchange Commission, Federal Register / Vol. 75, No. 120 / Wednesday, June 23, 2010 / Proposed Rules, page 35921.

Elmer,

If only life were that simple. You can twist data to conclude you want:

Figures don’t lie but liars do figure.

With business, especially a young one, you have to, unfortunately, rely on people
with common sense, knowledge and the willingness to use them.

I’m not willing to trade the thoughts of Mssrs. Boslego, Lauder and Surz for what any robots with
spin artists have to say.

Brooke

Hooray !!

“Our staff has reviewed a sample of target date fund marketing materials and found that the materials often characterized target date funds as offering investors a simple solution for their retirement needs. The materials typically presented a list of funds with different target dates and invited investors to choose the fund that most closely matches their anticipated retirement date. Even though the marketing materials for target date funds often included some information about associated risks, they often accompanied this disclosure with slogan-type messages or other catchphrases encouraging investors to conclude that they can simply choose a fund without any need to consider their individual circumstances or monitor the fund over time.”

Source: SEC, Federal Register / Vol. 75, No. 120 / Wednesday, June 23, 2010 / Proposed Rules, page 35922.

OK, so when advising advisors and investors personal opinions of online commentators are the best basis for a decision?

“The U.S. Securities and Exchange Commission’s Investor Advisory Committee adopted recommendations today asking the agency to rewrite its proposed rule on target-date retirement funds.

“The recommendations adopted by the committee at a meeting in Washington would expand a 2010 SEC proposal by requiring increased disclosures to investors in the funds about their fees and risks.

“’In making this change in disclosure, we are actually going to teach investors something really important that most of them don’t understand,” said James Glassman, a committee member and founding executive director of the George W. Bush Institute, said at the hearing. ‘There is more to risk than asset allocation.’”

“’The risks were not well understood by fund participants,’ said Barbara Roper, an advisory committee member and director of investor protection at the Washington- based Consumer Federation of America.”

Source: Target-Date Fund Rule Revisions Urged by SEC Advisory Committee, Bloomberg, April 11, 2013.

“’The risks were not well understood by fund participants,” Well of course. Should investors use any investment for retirement they don’t clearly understand? What is the fiduciary duty?

Sounds like TDS funds are “not ready for prime time.” Sales claims aside.

“On a survey commissioned by the SEC, only 36 percent of respondents (including 48 percent of target date fund owners and 26 percent of non-owners) correctly answered a true-false question regarding whether target date funds provide guaranteed income after retirement.”

• “More than half of all respondents (54%) failed to correctly indicate that TDFs with the same year in their names do not necessarily have the same mix of stocks and bonds at the target date.”

• “Only 9% of all respondents correctly answered that none of a series of statements about similarities among TDFs with the same target date were true; 50% incorrectly answered that the mix of investments of two 2020 target date retirement funds reaches its most conservative point in 2020.”

• “Over 50% of TDF owners expected that a TDF’s stock allocation would be 40% or less at the target date.”

Source: “Investor Testing of Target Date Retirement Fund (TDF) Comprehension and Communications,” Submitted to the Securities and Exchange Committee by Siegel and Gale, February 15, 2012.

These findings prove ignorance of material facts.

“Even many professional pension fund consultants who help select retirement plan fund
options offered through defined contribution plans under-estimate the degree of risk in
many target date funds. For example, one unpublished study5 found that, although target
date funds on average exposed investors nearing retirement to a significantly higher
maximum potential loss than most pension consultants surveyed deemed appropriate for
those nearing retirement, only about 35 percent of those pension consultants viewed
current glide paths as somewhat to highly inappropriate (i.e., too aggressive). In other
words, almost two-thirds of these pension consultants assumed that funds were invested
more conservatively than was in fact the case.”

Source: Recommendation of the Investor Advisory CommitteeTarget Date Mutual Funds
(Adopted April 11, 2013).

I did not state a claim that TDFs are bad, contrary to the line in this article:

“Claiming that target date funds are bad because they are misunderstood by investors is rather ridiculous.”

I agree with the SEC’s conclusion:

“Well-designed target date funds can provide a cost-effective long-term investing solution for the many individual investors who find it difficult to construct and maintain a diversified portfolio with risk levels changing to match their evolving needs.”

Source: SEC Advisory Committee, April 11, 2013.

It’s a question of adjusting risk levels to match the evolving needs of people, and needs can vary a lot among people of the same age bracket.

I agree with Jim Lauder’s point in his article, Target-Date Managers Who Ignore Risk Should Be Fired, (May 3, 2013): “In most cases, plan participants would rather protect against downside risk than ramp up risk in pursuit of greater returns.”

That is the objective of Vertical Risk Management, to guard against significant downside loss. It should be expected to produce a lower return than taking unmanaged risk. But avoiding large losses can produce better returns. Taking larger risks does not guarantee higher returns. That is the nature of risk.

OK, so we have some data and government data. That is negative and contrary, in fact to claims of downside protection. Is there evidence countering that?

So what is a fiduciary’s responsibility given this fact base?

If the greater chance of loss (“risk”) does not produce a likelihood of greater returns why would the investment with more likely losses be chosen? Diversification? So the “risk-return” trade off does not apply to TD funds?

I think a fiduciary’s responsibilities are: (1) to help a client assess what level of risk is appropriate for the client, and (2) to understand the risks of a portfolio to ensure it matches the risks appropriate and tolerable for the client.

An investment with a lower expected return may be much more desirable if it has less maximum likely downside loss, especially when recovery periods are unknown, and the money is needed in 5 years or less.

I believe that active risk management is needed to guard against significant downside loss, and that means taking little or no risk during financial crises, when large losses may destroy retirement portfolios.

What are fid responsibilities in selecting and making funds available? If there is government data showing TD funds don’t work, yet, as promised – what then?

I COMPLETELY DISAGREE with the RAIBiz article. It is apparent the the articles author is getting their information from sources that not really reliable..

Any knowledgeable author of investment articles would have done the due diligence needed to find Morningstars’ Research Paper on Target-Date Fund Series. Anyone can get this off the internet for free. It is a 53-page report that provides investors, investment advisors and 401(k) advisors more than what they need to know.

This article is a lesson making serious errors to do not doing any meaningful due diligence!!!!!!

Grrrrrrrrrrr

Have any of you looked at the various glide paths of the various TD series funds.

There are some that are so conservation the plan administrator could be fired!!!!!

I have only been in this business for 5 months and it seems that most anyone could obtain this knowledge in the same time. Lots of advisors are being over paid and they do not have a good handle on TD funds..

No more comments & last post on the forum.

Incontrovertible Imperatives for Zero Risk at the Target Date
1. There is no fiduciary upside to taking risk at the target date. Only downside. The next 2008 will bring class action lawsuits.
2. There is a “risk zone” spanning the 5 years preceding and following retirement during which lifestyles are at stake. Account balances are at their highest and a participant’s ability to work longer &/or save more is limited. You only get to do this once; no do-overs.
3. Most participants withdraw their accounts at the target date, so “target death” (i.e. “Through”) funds are absurd, and built for profit.
4. Save and protect. The best individual course of action is to save enough and avoid capital losses. Employers should educate employees about the importance of saving, and report on saving adequacy.
5. Prior to the Pension Protection Act of 2006, default investments were cash. Has the Act changed the risk appetite of those nearing retirement? Surveys say no.
6. Ignoring the past (especially 2008) and hoping it’s different the next time is not an option, and it’s certainly not an enlightened view of risk management.
7. Surveys of fiduciaries say no risk.

Ron,
I suspect your comments are beyond most investment advisors. Absolutely no way to explain to plan administrators and fiduciaries.

If I was the plan administrator, I would have two TD fund series. Aggressive and conservative glide paths. Then provide education for the participants on these funds. Including executives, most participants have no ideas how to allocate there investments. Using charts it is Very Easy to explain.

Providing seminars to education participants that have little background on investment allocation is Wishful Thinking..

Paul Hutt

You wouldn’t be alone Paul. That’s exactly what John Hancock did — 2 products, aggressive and safe. If there are lawsuits, as I think there will be, which path exposes Hancock?

If there is public information that is pro or con an investment decision by a fiduciary:
1. Are they required to do a search?

2. Are they required to include the information in the record of their process?

On financial education:

“In response to such consumer deficiencies, governments, employers, and financial institutions have begun to engage in financial education. Examples of education initiatives include paycheck stuffers, newsletters, summary plan descriptions, seminars, individual consultations with financial planners, and access to Internet-based education and planning tools…

Unfortunately, studies of the effectiveness of such interventions have revealed mixed results. Although some researchers have decisions, others have critiqued this work for use of nonrepresentative samples, for the researchers’ reliance on statements of intention rather than actual behavior, and because it confounds a firm’s provision of financial education with other factors that influence saving behavior, such as the level and structure of…”

from Subjective Knowledge in Consumer Financial Decisions – LIAT HADAR, et al ’13

The word “mixed” in research means no worthwhile results.

This month T Rowe is coming out with a TD series. It is expect to be structured with a glide path with 45% in equities for those between the ages of 60 & 64.

Ron,
Question for you. Given that there are approximately 62 TD fund series it would seem that the Morningstar benchmarks would not work. The only thing I can think to get a relative good index is to construct one using TD funds that have a similar glide path.

What are your thoughts on this idea.

Ron, I have a question for you that I would like to discuss with you outside the the forum. If you have the time, I would appreciate you emailing me at paulhutt@wrpa.biz

Thanks,
Paul

There is are a vast # of articles on this. Do an internet search using some like ERISA 401(k) plans. You will get a # of links to DOL’s ERISA site. Pay particular attention to these.

The internet is your friend!!

I concur with the author of the article that TD funds are likely to continue to see growth in the defined contribution workplace. For the vast majority of workers, with little understanding of investments, TD funds as the qualified default appear appropriate. Moreover, plan sponsors possess the ability to fulfill their fiduciary duties by selecting high-quality TD funds.

DISCLOSURES ENHANCED. Certainly disclosures can be enhanced of downside risk. Providing historical (or simulated historical) data, in terms of value of $1,000 growth over time (year-by-year), might work far better than percentage disclosures, since few investors understand that the same percentage decline is more impactful than the same percentage advance. Enhanced disclosures might also include best and worst percentage advantages/declines over 1-month, 3-month, 1-year, 5-year and 10-year periods.

While better disclosures, including the use of charts and graphs, would be helpful, we must accept the fact that “investing” will remain “Greek” to the vast majority of plan participants, even after providing them with educational seminars and good educational materials. TD funds, selected appropriately, can be a cost-effective and paternalistic way for a fiduciary to fill the “understanding investments” void so many plan participants will possess.

WORKING BACKWARD FROM RETIREMENT. One issue, alluded to in the discussion, is what should be the target asset allocation at the point of retirement. With most investors possessing decades in retirement, many advisors recommend asset allocations ranging from 60% equities / 40% fixed income to 40/60.

I don’t accept the proposition that target date funds must possess very low risk (i.e., no possibility of a substantial decline) in the year prior to retirement. Rather, perhaps education should be for plan participants as to the appropriate retirement portfolio, and then work backward from there.

Moreover, target date funds can possess varying levels of risk. Such as “2020 conservative” vs. “2020 balanced” vs. “2020 aggressive.” Of course, a 2020 aggressive fund might be managed similarly to to 2030 conservative fund – or be the same fund, for that matter (albeit with different name).

RISK MANAGEMENT TECHNIQUES. It seems to me that the thrust of the original article was on the lack of implementation of risk management techniques by target date funds, as a means of providing downside protection, especially as one approached retirement. There are many risk management techniques portfolio managers can employ. Here are a few …

RISK MANAGEMENT / LAYER CAKE APPROACH. During retirement a way of providing assurance to an individual client would be the use of the “layer cake” approach, in which a portion of the portfolio is allocated to withdrawals over the next few years, a portion is allocated to mid-term needs, and another portion is allocated to long-term needs. I believe Harold Evensky came up with this methodology, and he has written about it in the past. In essence, during market downturns the “short-term layer” may be drawn down, until asset class valuation levels return to near-normal levels. I see how the layer cake approach can add value, both in terms of enabling the client of an advisor to avoid bailing out of the market during downturns (i.e., “selling low”), and also in terms of providing a different means to undertake portfolio rebalancing. However, I also note the original article author’s proposition that at times market downturns can be prolonged over decades, not just 3-5 years. It may be possible to add value to a client’s portfolio using a layer cake approach, but I do not suggest that it eliminates all risk.

However, whether a layer cake approach can be utilized in a target date fund is another question. A significant amount of hand-holding is likely required to enable an individual investor to understand and adhere to the layer-cake approach. Also, incorporation of personal financial planning (as to when funds are needed, discussing discretionary vs. nondiscretionary expenditures in retirement, etc.) may be a prerequisite to the use of this technique.

Hence, perhaps the question should be asked … should all plan participants be permitted to withdraw (i.e., rollover) assets from qualified retirement plan accounts after a certain age? Should all plan participants be encouraged to consult with individual financial advisors five or more years prior to retirement, and possibly move out of target date funds into a different type of strategy during such time frame?

RISK MANAGEMENT / OPTIONS. The idea of providing downside risk to any investment portfolio, whether it be a TD fund or otherwise, typically involves the use of options. It is difficult to back-test such strategies over long time periods, given the lack of data on option prices going back for decades. An article providing extensive (long time period) back testing, with data shown, would be helpful to aid in this discussion. It seems to me that the use of risk management, through options, is a broader issue affecting not just TD funds, but nearly all investment portfolios.

RISK MANAGEMENT / AVOIDING FINANCIAL CRISIS. Another commentator suggests that TD funds should avoid risky investing during times of financial crises. This presumes that the fund manager can predict when such crises may occur. Certainly there were some managers and advisors who were insightful enough to predict the 2008 financial crisis; yet 90% or more did not. The ability to predict macro-economic events, including financial shocks, in my opinion cannot reliably be done by the vast majority of TD fund managers. I doubt TD fund managers will assume any obligation to avoid financial crisis, when there is a high degree of likelihood that they will be unable to predict such events.

Since the 2008-9 financial crisis I have often pondered how macroeconomic risks (or shocks) can be detected/predicted/ascertained, in advance, by investment advisers. As a student of economics and investing, I have been most interested in this topic. Yet, it seems to me that while there may be some advisors who possess the ability to discern financial crises before they occur, I don’t believe I possess that ability. And I am doubtful that TD fund managers, to any significant degree, also possess that ability.

RISK MANAGEMENT / TACTICAL ASSET ALLOCATION VIA ASSET CLASS VALUATION LEVELS. While the 2008-9 downturn was not triggered by a huge overvaluation in equities (unlike 2000-2002, when growth stocks were hugely overvalued), tactical asset allocation strategies could be considered by TD funds in reaction to asset class valuations relative to perceived (or estimated) historic norms. There are many tactical asset allocation strategies based on estimates of asset class valuations; one cannot conclude that they are all doomed to fail, even though the academic research suggests that, on average, tactical asset allocation strategies do not outperform portfolios managed through strategic asset allocation with a disciplined approach to rebalancing.

RISK MANAGEMENT / ANNUITIZATION. Should annuitization strategies be recommended to plan participants, as they approach retirement? Lots of recent academic research in this area, with varying conclusions.

RISK MANAGEMENT / FEES AND COSTS. Lastly, an issue with TD funds is their fees and costs, relative to other investment options made available within the qualified retirement plan. Some criticism of some TD funds has been based on the fact that some TD funds incorporate, as their components, higher-cost funds, relative to index funds or other funds offered within the plan. This is a risk issue for fiduciary plan sponsors.

Plan sponsors, aided by knowledgeable, objective fiduciary (and truly objective) advisors, should be able to discern the total fees and costs of TD funds, and select for the plan the lower-fee-and-cost TD funds available in the marketplace (taking into account other factors in the selection process), as appropriate. Defined contribution plans can enjoy economies of scale, resulting in very low fee levels for plan participants. Given the substantial academic evidence supporting the strong correlation between higher fees/costs and lower long-term returns of funds, fiduciary advisors can play an important role in discerning and recommending lower-fee-and-cost TD funds to plan sponsors. This, in turn, will likely generate competitive pressures on TD fund sponsors to provide better offerings.

CONCLUSION. This discussion has many threads. I would conclude, as to these questions posed:

There are many different risk management strategies designed to avoid or minimize downside risk, or to properly manage the portfolio during a period of substantial declines. More research and discussion of risk management techniques is proper. More extensive back-testing is required to assess the long-term costs and benefits of such techniques. I would appreciate more articles on the subjects discussed below – i.e., use of options, layer cake approach, etc.

Can we eliminate the “retirement crapshoot”? By that, I mean, can financial success in retirement not be dictated by “luck” as to when one retires, as to the subsequent investment returns sequence in the crucial years immediately following retirement? Can risk management techniques be utilized, either alone or in combination, to provide greater certainty in an uncertain world?

Wow. Long. Clearly TD funds sell, we assume because of the sales promises. Whether they fulfill those promises is a matter of the data. The research quoted suggest not. No one has provided andy evidence they do. If there were we have to assume those facts would be widely promoted

So we have three questions: – Because a retirement product is demanded and successfully sold – should it be. Madoff was very successful his promises, for which there was growing demand.

- Realistically, how productive will more financial education be? The evidence says likely very little.

- What is the evidence that the loss/“risk” management techniques and theories are any more effective than those for TD funds. Options in retirement plans!? How is raising the chance of loss managing the threats of loss?

Finally, back testing is not evidence – it is just post hoc curve fitting.

There is gold in them life savings!

“BlackRock, the world’s largest asset manager, is starting 10 indexes that will let investors approaching retirement calculate how much their savings will equal in annual income when they turn 65. The New York-based firm filed with the Securities and Exchange Commission to offer five investment-grade bond mutual funds that will be linked to the indexes, which adjust for variables including interest rates<sup class="footnote"><a href="#fn64a69f7a-60b5-4049-bb0d-d069db5ecaf9" rel="nofollow">2</a></sup>, inflation and assumptions about lifespans.

Led by Chief Executive Officer Laurence D. Fink, BlackRock last year started a five-year branding campaign and reorganized its leadership to help improve fund performance as it seeks to expand its retail business. The firm has less than a 2 percent market share in open-end mutual funds, compared with 11 percent for Boston-based Fidelity Investments<sup class="footnote"><a href="#fnb26f5d48-eeb0-4a8d-a0a0-937c8591af24" rel="nofollow">3</a></sup> and 12 percent for American Funds<sup class="footnote"><a href="#fna5023cb0-0785-4301-9a1a-17c89cb3f2a2" rel="nofollow">4</a></sup>, run by Capital Group Cos. in Los Angeles<sup class="footnote"><a href="#fn992af0e4-1b0a-4469-973e-2258ff1d6726" rel="nofollow">5</a></sup>, according to data from Morningstar Inc. (MORN)<sup class="footnote"><a href="#fn86037663-e5d0-4da3-a669-1d0548c0226d" rel="nofollow">6</a></sup>“

Or market top?

Is retirement money profitable? Oh yeah!

“Managing money for individuals is a lucrative business. It represented about 11 percent of BlackRock’s $3.86 trillion assets under management as of June 30, while accounting for 33 percent of long-term asset base fees” Wow!

Mr. Rhodes has supplied a lot of interesting and thoughtful material here and has raised a number of key questions. Being the author of the original article, I would like to make a few points:

1) We should differentiate between whether an employee (investor) chooses a Target Date Fund (TDF), or whether it is a “choice” by default. If the investor selects it, employers can presume a minimal level of review. If it is a default “choice,” employers should presume that the investor has not read the material. In the latter case, I think employers should be much more careful in what risks “default investors” are subjected.
2) Subjecting default investors to unmanaged market risks with potentially large losses, as experienced by the major 2010 TDFs, shown in my article (Exhibit 3), does not seem appropriate to me, if the investment represents a sizable portion of default investors financial assets. The majority of pension consultants surveyed agreed that that was too much risk, and in fact thought the TDFs were more conservatively invested and managed than they were.
3) One logical conclusion is that the consultants did not understand how risky the strategies were. I would go further and say that perhaps many of the TDF managers did not understand either.
4) The collapse of 2008 occurred after a 20-year period of good stock market returns. It came as a surprise to many, as Mr. Rhodes stated.
5) The widely practiced investment strategy of holding and rebalancing equity market positions for the long-term exposes investors to potentially large losses, as I demonstrated in my article (see Exhibit 4). It seems inappropriate to me to give a “default investor” that large a market risk in the last 5 years before retirement, if at all.
6) Managing a default investor’s “longevity risk” by preserving purchasing power seems appropriate. For example, TIPS— Treasury Inflation-Protected Securities – may be purchased as a hedge against inflation. The fees charged to the default investor—the other topic—could also be minimal if this is what they own.
7) When people retire, statistics show that the vast majority of them exit TDFs. This implies that either the risks or the fees, or some combination, of the existing products don’t appeal to them. This implies that many “default investors” would not choose the most popular existing products.
8) There is further evidence of this point provided in the study: Investor Testing of Target Date Retirement Fund (TDF) Comprehension and Communications, Submitted to the Securities and Exchange Committee by Siegel and Gale, February 15, 2012. In the section, “Effect of TDF Document Review on Investor Decision-Making,” statistics show that owners of TDFs said they were less likely to include a TDF in their portfolios after reviewing the documents describing them, and were less likely to believe that they are “safe” investments.
9) I believe that the average person can understand basic information about investments based on points 7 and 8 above. I think that default investors may not spend the time necessary to review documents because they expect fiduciaries to more safely invest their retirement savings.
10) This brings me to risk management and Mr. Rhodes’ statement: “More research and discussion of risk management techniques is proper. More extensive back-testing is required to assess the long-term costs and benefits of such techniques. I would appreciate more articles on the subjects discussed below – i.e., use of options, layer cake approach, etc.” I will have a lot more to say about this later.
11) My first point though is that risk management need not require forecasting macroeconomic events. Vertical Risk Management (VRM) is a method that responds to market forces in a systematic way, with the goal of preventing major losses (drawdowns).
12) Mr. Rhodes stated: “Academic research suggests that, on average, tactical asset allocation strategies do not outperform portfolios managed through strategic asset allocation with a disciplined approach to rebalancing.” The goal of VRM is not to outperform the market in terms of earning a higher return, which is how “outperforming” is usually measured. The goal is to provide greater certainty in an uncertain world.
13) I have assessed the risk preferences of many CEOs/CFOs in the energy industry for over two decades and I can tell you that the vast majority of them will choose to take less market risk when their earnings objectives are met through pro-active risk management (hedging). I think many individual investors would make the same choice to take less risk when their retirement goals are met.

Back-testing and “risk’ modeling nearly collapsed the world’s economy and strongly contributed to the longest and one of the most severe set of losses and value destruction in history. What’s changed?

Why engage in energetic denial – again? It’s public record.

On moving into, my spouse requested me who was on the door and that i described that it was an older man asking me if I wanted to get an apple pondering that potentially he is a burglar casing the house to check out if any one is home!

This might conceivably be the beginning of a larger war between the two giants, involving not only eBooks, but also music, movies and all the other miscellaneous applications that have come for being associate together with the iPhone and, no question, the iPad.