Target Date Funds: Testimony by Morningstar
John Rekenthaler, Vice President of Research for Morningstar, recently testified before the U.S. Senate Committee on Aging concerning target date funds.
In his testimony, he stated that, while Morningstar was generally supportive of target date funds, they had at least five concerns. Those concerns included:
- High expense ratios. A material variation in fees among the target date fund families, ranging from 0.19% to 1.82% . . . that is a range of over 900%.
- The use of proprietary (in house) funds within the target date family. In his testimony, Rekenthaler raised concerns about single fund families being experts at managing investments in all of the asset classes that should be included in a target date fund. Some providers avoid that problem by using sub-advised funds, where they seek out experienced advisory firms for the particular kinds of investments.
- Lack of management ownership. Morningstar finds that there is little personal ownership of target date funds by the managers of those funds. That concerns the Morningstar people, because they have found that mutual funds with a high percentage of management ownership tend to perform better.
- Variation in glide paths among the shorter-dated funds. By “shorter-dated” funds, Rekenthaler is referring to the 2010 funds, 2015 funds and 2020 funds, where there is the greatest variation in the allocations to equities. In other words, 2010 funds vary more to a much greater degree than 2050 funds . . . surprisingly.
- Lack of transparency. Rekenthaler bemoans the fact that even Morningstar has difficulty with the transparency of target date funds. In his testimony, he states: “In gathering the data for its Industry Survey, Morningstar struggled to collect even the basic stock/bond/cash information for some of the target-date funds. Details such as the allocations between domestic and international stock, or corporate and government bonds, were even harder to obtain. If Morningstar with its market presence and staff of data experts scrambled to learn the characteristics of the industry’s target-date funds, then surely the every day employee who seeks to learn more about his default investment faces real difficulties.”
Undoubtedly, the current “re-examination” of target date funds is going to produce changes. The testimony of experts, such as Rekenthaler, will accelerate that change and, hopefully, will ensure that the right changes are made.
A copy of the Morningstar testimony is being distributed together with this newsletter. A copy can also be obtained from our law firm website at www.reish.com/publications/pdf/rekenthaleroct09.pdf.
Plan sponsors should consider these issues in selecting and monitoring their target date funds.
Any U.S. federal income tax advice contained in this communication (including any attachments) is neither intended nor written to be used, and cannot be used, to avoid penalties under the Internal Revenue Code or to promote, market or recommend to anyone a transaction or matter addressed herein.
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