Compliance December 16, 2009

Senator Says Target-Date Legislation Coming

Regulators might already be taking a harder look at target-date funds, but it now looks as though Congress will get into the mix as well.

Reported by

U.S. Senator Herb Kohl (D-Wisconsin), chairman of the Senate Special Committee on Aging, today announced his intent to introduce legislation that will require target-date fund managers to take on a fiduciary responsibility in order for such funds to be eligible for the designation of qualified default investment alternative (QDIA).  

Junk Yarn

Reacting to a Bloomberg report that six of the nine largest U.S. target-date fund providers contain junk bonds in their 2010 portfolios (see “Some Target-Dates Visit the ‘Junk’ Shop“), Kohl said “the discovery that many 2010 target-date funds contain junk bonds is troubling, but not surprising. Many target-date funds are composed of hidden underlying funds that can have high fees, low performance, or excessive risk. With more than 90% of employers choosing off-the-shelf target date funds as their employee’s standard option, there is no question that we need greater regulation and transparency of these products.” 


Kohl, whose committee convened one of the first hearings on the subject of target-date funds in February, recently chaired another hearing titled “Default Nation: Are Target-Date Funds Missing the Mark?” (see “Senate Committee Takes Aim at Target-Date Funds”).  During that hearing, witness Michael Case Smith of Avatar Associates made the point that the firms that put together target-date fund allocations—which frequently include proprietary fund offerings—were not doing so as an ERISA fiduciary.

Advisory Opinion

It was a case the firm also presented to the Labor Department recently for an advisory opinion, though the DoL said that the fact that a target-date or lifecycle mutual fund’s assets consist of shares of affiliated mutual funds “does not, on that basis alone, make the assets of the target-date or lifecycle mutual fund ‘plan assets’ of investing employee benefit plans or the investment advisers to such mutual funds fiduciaries to the investing plans under the Employee Retirement Income Security Act (ERISA)” (see “DoL: Advisers to Funds in Target-Dates not Fiduciaries”). 

That result was noted by Kohl in his announcement: “Last week DOL released an advisory opinion stating that fiduciary responsibility of target-date funds currently resides with the employer. The problem is that employers are often unaware of the investments which compose each target date fund, as they are determined by a fund manager. Further, increasing the fiduciary liability for employers in the case of QDIAs may decrease the likelihood that they will adopt auto-enrollment policies and therefore reduce the retirement security of their employees.” 

Expanding Responsibility

Kohl went on to note that it is, however, “critical that the fiduciary responsibility rest with someone so that default investors are protected.”  According to the announcement, Kohl’s forthcoming legislation will “improve the scrutiny of target-date funds by expanding the fiduciary responsibility of target-date fund managers.”

“As it stands, target-date products operate under less stringent fiduciary responsibility guidelines. The problem is that the people who are defaulted into target-date funds are the ones who need someone looking out for their financial interests the most,” Kohl said. “We need to ensure that automatic enrollees benefit from the same fiduciary protections as other investors.”

The Markets December 16, 2009

Some Target-Dates Visit the ‘Junk’ Shop

A Bloomberg news report said six of the nine largest U.S. target-date fund providers by assets have junk bonds in their 2010 portfolios.

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The Bloomberg story said that while John Hancock’s Lifecycle 2010 mutual fund is marketed as an investment that “becomes more conservative” for people approaching retirement age, 35% of the fund’s debt holdings in September were high-yield corporate bonds, according to Morningstar Inc.

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For example, according to Bloomberg, the Hancock fund’s holdings include bonds that financed construction of a New Mexico casino hotel, Inn of the Mountain Gods, which was in default as of December 15. The U.S. default rate on high-risk, high-yield bonds was 11.28% in November, according to Standard & Poor’s.

A single bond in default is “not going to make or break the fund” because it’s a very small portion of the thousands of bonds in the fund, Bob Boyda, senior vice president in the investment management services division of John Hancock told Bloomberg. “Even if a bond is in default it may have tremendous value.”

The problem, according to Laura Pavlenko Lutton, editorial director in Morningstar’s mutual-fund research group: Target-date funds may present greater risks than consumers have been aware, Bloomberg reported. The target-date funds blossomed into a $311-billion business by 2008, a year after the U.S. Department of Labor said employers may use them as an automatic enrollment investment option for 401(k) plans.

Junk Bond Amounts

Other 2010 retirement funds with bonds rated below investment grade include: Principal Funds LifeTime 2010 Fund, at 21% of its total debt holdings; the Fidelity Freedom 2010 at 17.1%; T Rowe Price’s Retirement 2010 Fund at 13.1%; American Funds’ American 2010 Target Date Retirement Fund at 11.4 %; and TIAA-CREF’s Lifecycle 2010 Fund at 6.6%, as of the latest portfolio disclosure, according to Morningstar.

Jonathan Shelon, manager of Fidelity Investments’ Freedom Funds, told Bloomberg that risk is only one of the concerns that someone who’s about to retire needs to consider. They also need to generate enough income to last during their retirement years, he said.

Meanwhile, Principal Financial Group and TIAA-CREF said their allocation in high-yield bonds also offers diversification, according to spokeswomen for the companies.

Bloomberg said three of the nine largest target-date fund companies don’t have any junk bonds in their 2010 or 2015 target-date funds: Vanguard Group, Wells Fargo & Co., and ING Groep NV. Their overall bond holdings range from 35% in ING’s fund to 65% in Wells Fargo’s fund.

Vanguard Group’s avoidance of high-yield bonds is “very conscious,” said John Ameriks, head of the company’s investment counseling and research group. Junk bonds wouldn’t add “significant diversification,” and would raise expenses, he said.

Junk Bond Objections

“I am extremely disturbed by the amount of junk bonds found in many 2010 target-date funds,” said Senator Herb Kohl, a Wisconsin Democrat and committee chairman. “Stronger regulation is needed to ensure that participants on the brink of retirement are not exposed to such excessive risk.”

Kohl said in a statement he will introduce legislation to require target-date fund managers to act as fiduciaries if their plans are offered as automatic enrollment options in 401(k) plans (see “Senator Says Target-Date Legislation Coming“).


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