The SEC proposed amendments to rules 482 and 156 under the Securities Act of 1933 and rule 34b-1 under the Investment Company Act of 1940 regarding target-date retirement funds.

In a letter sent Friday from Morningstar to Elizabeth Murphy, secretary of the SEC, the investment company outlined its suggestions for improving the disclosure of the management and structure of target-date funds to investors as well as financial advisers, consultants and plan sponsors. Investors need to be able to understand how the funds are run, and plan professionals and administrators need to able to adequately assess their potential risks and rewards, Morningstar said, as well as to evaluate them side by side.

Target-date funds have become a key feature of employer-sponsored defined contribution (DC) plans. According to a study from Vanguard,  82% of its retirement plans offer target-date funds, the letter said. The Pension Protection Act of 2006 allows target-date funds to be designated as Qualified Default Investment Alternatives Assets, which has accelerated the asset growth of these funds. Morningstar estimates that target-date mutual funds held approximately $378 billion at year-end 2011, and billions more are invested in institutional and private target-date accounts, such as collective investment trusts, that are not yet required to disclose assets under management.

These funds have also become more diverse. There are now 48 distinct target-date mutual fund series, each with its own interpretation of how a target-date fund should be constructed. While some target-date series are relatively straightforward, many of the industry’s newest entrants are notable for their very distinctive designs, according to Morningstar.

Not All Disclosures Are Made Equal 

According to Morningstar, the SEC’s goal of improving  investors’ understanding of a target-date fund’s asset allocation would not be met by requiring each target-date fund to disclose its asset allocation at the target date adjacent to the first use of the fund’s name in marketing materials.

Morningstar maintains that the series’ asset-allocation at all points along the glide path should be disclosed clearly as part of the funds’ prospectus.

The investment company specifically objected to the proposed naming convention in marketing materials for the funds. Highlighting this one data point would be misleading, Morningstar said. It would overemphasize the importance of a single point in time for an investment that is designed to change over decades.

Moreover, the target-year allocation disclosure could be confusing. Most investors choose target-date funds within their DC plan, which typically offers a single target-date series. As a result, every fund in the series that precedes its target date would have the same asset allocation at the target date, even though the funds are designed for participants of varying ages and may have vastly different allocations at the time of enrollment.

Visual Representation Is Better 

Instead of highlighting the funds’ asset allocations at a single point, Morningstar is in favor of requiring marketing materials for target-date funds to include a graphical depiction of the asset allocation over time—in other words, a glide path. The SEC’s study found that respondents who reviewed documents with a glide path illustration better understood target-date funds than those who reviewed documents without the illustration.

This disclosure would be even more effective with detailed guidelines for glide-path disclosure. Target-date providers should retain some flexibility as to how they represent their glide paths, but investors need clear disclosure of meaningful asset-class exposures, the letter said. Allocations to those less-traditional asset classes can have a significant impact on series’ risk profiles. Morningstar suggests that target-date funds disclose intended allocations to broad asset classes representing more than 10% of a fund’s assets, and such exposures should be included in the glide-path graphic. The target-date industry would benefit from clear guidelines from the SEC, outlining what types of investments constitute each broad asset class.

Morningstar recommends graphic representation of glide paths for at least three asset class exposures. Even better, they said, would be a graphic with a more detailed depiction of asset-class exposures at all points along the glide path.

The letter was from Morningstar divisions in fund research, investment profiles, data, software and Ibbotson Associates, a Morningstar subsidiary, and can be seen with examples of graphs and tables here.