Congressional Request for Review of Target Date Fund Risk
On May 7, 2021, 401(k)Specialist magazine published Concern Over ‘Certain’ TDF Risks Prompt Congressional Request for GAO Review, reporting that:
“Yesterday, Senator Patty Murray (D-WA), Chair of the Health, Education, Labor, and Pensions (HELP) Committee, and Rep. Bobby Scott (D-VA), Chair of the House Education and Labor Committee, sent the letter to the GAO seeking answers to 10 questions dealing with concerns that some aspects of TDFs may be placing American retirement savers at risk.”
Most of the 10 questions pertain to risk near the target date, with expressed concern for beneficiaries over the age of 55. Senator Murray and Representative Scott want to know if the risk of loss is mitigated. The unfortunate answer is that risk is not mitigated in most TDFs. It’s somewhat less at the target date than it is for younger people, but it is still substantial. The next market crash will devastate those near retirement.
I address the 3 main questions in the following. My answers are specific to the Big 3 oligopoly – Vanguard, Fidelity, and T Rowe Price – who collectively manage 65% of the $2.5 trillion in TDFs, and I contrast these to the few very safe TDFs.
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Most TDFs are like the Big 3 but there are a few exceptions. The variance in risk near the target date comes in two clusters. Most funds and assets are in the “Big 3 Cluster” but a few TDFs are similar to the patented Safe Landing Glide Path tracked by the SMART TDF Index and the OPEIU Union National Retirement Savings Plan (NRSP)
1. How did near-dated TDFs fare in the pandemic?
The following exhibit from one of our shows tells the story
Most importantly, these results are a reminder of what happened in 2008:
These losses prove that most TDFs cannot and have not withstood major stock market turbulence, but the SMART TDF Index is an exception. The answer to the next question explains why.
2. What is the shift to conservative investments and are participants aware
The following image from this show contrasts glidepaths to surveys of what participants want.
Participant preferences have been ignored, but they are not aware of it because plan sponsors choose TDFs. Plan sponsors and their advisors are ignoring participant needs and preferences.
Most TDFs are 90% in risky assets at the target date : 55% in risky equities plus 35% in risky long-term bonds. Bonds will not protect in the next market crash as they did in 2008. By contrast, SMART is less than 20% in risky assets at the target date, in line with survey preference.
3. How are TDFs selected?
There are serious conflicts of interest in the selection of TDFs as explained in this article and this picture:
Beneficiaries want to be protected from losses, as revealed in surveys. Fiduciaries, namely plan sponsors and their advisors, want to be protected from lawsuits and believe that the Big 3 are the only way to do so because of procedural prudence since most plans use the Big 3. Investment companies want profits and have designed their TDFs accordingly.
It will be interesting to see what the GAO does and if it responds at all. TDFs need reform. Let’s hope it can happen before the next market crash because this time there is much more at stake than in 2008 — $2.5 trillion today versus $250 billion then. Congress did not act following the joint SEC-DOL hearings on TDFs in June 2009 and they probably won’t in this case. The intention is to allow fiduciary choice, rather than mandate a risk level. We can hope that the GAO report will enlighten fiduciaries who will move to protect beneficiaries.