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Target Date Funds
FRED REISH, ESQ.
November 6, 2014
The Importance of Fiduciary Compliance
“It is estimated that in the near future ‘between fifty
and sixty percent’ of all plan assets held in
individual account plans will be invested in TDFs.”
Comment: Follow the money . . .
DOL Advisory Council on Employee Welfare and Pension
Benefit Plans, “Report on Hard to Value Assets and Target
Date Funds.”
Target Date Funds  November 6, 2014
1
Fiduciary Safe Harbor for Defaults
The Pension Protection Act added section 404(c)(5) to
ERISA to create a defense (sometimes called a “safe
harbor”) for fiduciaries who invest the accounts of
defaulting participants.
The purpose was to encourage the adoption of
automatic enrollment, but the fiduciary benefits go
beyond that to all defaults.
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Secondary Effects of QDIAs
The 404(c)(5) legislation and the DOL’s regulation (the
“QDIA” regulation) reflect a strong policy in favor of
investing participants in “portfolio” investments, rather
than in individual mutual funds.
Further, portfolio investing is consistent with ERISA’s
investment principles, which are based on generally
accepted investment theories, such as modern portfolio
theory.
Note: Purpose of ERISA §404(c).
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Fiduciary Duty
Although fiduciaries are relieved of liability for investing
defaulting participants’ accounts in a QDIA, they remain
responsible for prudently selecting and monitoring the
QDIA:
“[n]othing in [the regulation relieving fiduciaries of liability
for losses resulting from a participant’s investment in a
QDIA] shall relieve a fiduciary from his or her duties under
part 4 of title I of ERISA to prudently select and monitor
any qualified default investment alternative . . .”
Field Assistance Bulletin No. 2008-03—Guidance Regarding
Qualified Investment Alternatives (29 CFR 2550.404c-5).
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Good Idea, Bad Timing
“The Committee’s investigation found that there are
significant differences in the asset allocation of target
date retirement funds, . . . one 2010 target date
retirement fund with such holdings lost over 40 percent
in 2008. A loss of this magnitude simply should not
occur in a financial product that was designed and is
specifically advertised to limit risk and volatility as one
nears retirement.”
Letter from Senator Kohl to Chairman of the SEC, February 24, 2009.
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Target Date Investments
Senator Kohl urged the SEC and DOL to follow up.
On June 18, 2009, the DOL and SEC held a joint
hearing, focusing on the following questions:
• How TDF managers determine asset allocations and
changes to asset allocations (including glide paths) over
the course of a TDF’s operation;
• How they select and monitor underlying investments;
• How the foregoing, and related risks, are disclosed to
investors; and
• The approaches or factors for comparing and evaluating
TDFs.
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Results: TDF Promises
To what extent do you agree with these statements:
Investing in target date funds means that . . .
Agree
(Strongly or
Somewhat)
Do Not Agree
(Strongly or
Somewhat)
You will be able to retire on the target date
61.8%
38.3%
You will earn a guaranteed return
37.9%
62.2%
You can spend less time tracking your progress toward
your retirement goals
62.2%
37.9%
You can stop worrying about investment and savings
decisions and leave everything up to an investment
professional
48.7%
51.4%
Investor Perceptions of Target-Date Funds, April 2009, by Envestnet and Behavioral Research Associates.
Target Date Funds  November 6, 2014
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Target Date Funds
Outcome and Issues:
• DOL: Proposed amendments of QDIA and participant
disclosure regulations
• DOL and SEC: Information for participants (Investor
Bulletin)
• SEC: Guidance regarding marketing materials
• DOL: Tips for fiduciaries
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SEC Target Date Proposal
On June 16, 2010, the SEC proposed significant
changes to disclosures regarding target date funds, their
asset allocations and their glide paths.
Among the most important changes are:
• The SEC’s proposal would require marketing materials
for a target date fund that includes the target date in its
name to disclose the asset allocation of the fund.
• The SEC’s proposal would also require target date
marketing materials to include a prominent table, chart,
or graph that clearly depicts the asset allocations
among types of investments over the life of the fund.
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SEC Target Date Proposal
These proposals would also require a statement:
• explaining that the asset allocation changes over time;
• noting the asset allocation eventually becomes final and
stops changing;
• stating the number of years after the target date at which the
asset allocation becomes final; and
• providing the final asset allocation.
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SEC Target Date Proposal
The SEC’s proposal would require target date marketing
materials to include a statement informing the investor:
•
To consider the investor’s risk tolerance, personal
circumstances, and complete financial situation.
•
That an investment in the fund is not guaranteed and
that it is possible to lose money by investing in the fund,
including at and after the target date.
•
In addition, funds would be required to add a statement
in their marketing materials warning that the funds come
with risks and should not be chosen based solely on
investors’ retirement dates.
Target Date Funds  November 6, 2014
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Proposed Amendment to 404a-5
Regulation
The DOL has proposed to amend the participant
disclosure regulation to add a number of requirements
for TDFs, including the following:
 An explanation of the asset allocation, how it
changes over time, and the point in time when the
TDF will reach its most conservative asset
allocation.
 Including a chart, table or other graphical
representation that illustrates those changes in
allocation over time.
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Proposed Amendment to 404a-5
Regulation
 If the TDF is named with reference to a particular
date, an explanation of the age group for whom the
TDF is designed, the relevance of the date, and
any assumptions about contribution and withdrawal
intentions on or after that date.
 A statement that the TDF may lose money,
including losses near or following retirement.
Note:Similar amendments were proposed for the QDIA regulation.
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Outcomes
• Final regulations
• Little government intervention
• Focus on asset allocation
• Better information for plan sponsors, as fiduciaries
• Better communication with participants
• Prudent process and informed decisions by
fiduciaries
Target Date Funds  November 6, 2014
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Legal Issues and Practical Consequences
The preamble to the QDIA regulation says:
“The selection of a particular qualified default
investment alternative (i.e., a specific product, portfolio
or service) is a fiduciary act and, therefore, ERISA
obligates fiduciaries to act prudently and solely in the
interest of the plan’s participants and beneficiaries.
A fiduciary must engage in an objective, thorough, and
analytical process that involves consideration of the
quality of competing providers and investment
products, as appropriate.” [Emphasis added.]
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The Prudent Person Rule
ERISA requires plan fiduciaries to act prudently:
“[A] fiduciary shall discharge his duties … with the
care, skill, prudence, and diligence under the
circumstances then prevailing that a prudent man
acting in a like capacity and familiar with such
matters would use in the context of an enterprise
of a like character and with like aims . . . .”
[Emphasis added.]
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Prudent Process
A prudent process requires:
“With regard to an investment . . , the
requirements of . . . the Act . . . are satisfied if the
fiduciary (A) has given appropriate consideration
to those facts and circumstances that . . . the
fiduciary knows or should know are relevant to
the particular investment . . ; and (B) has acted
accordingly.” [Emphasis added.]
[Department of Labor [DOL] Reg. §2550.404a-1(b).]
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Tips from DOL for Fiduciaries
“TDFs may have different investment strategies,
glide paths, and investment-related fees.
Because these differences can significantly affect
the way a TDF performs, it is important that
fiduciaries understand these differences when
selecting a TDF as an investment option for
their plan.” [Emphasis added.]
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Prudent Selection of TDFs
The DOL Tips for Fiduciaries also says:
“You should consider how well the TDF’s
characteristics align with eligible employees’ ages
and likely retirement dates . . . the possible
significance of other characteristics of the
participant population, such as participation in a . .
. defined benefit pension plan . . . , salary rates,
turnover rates, contribution rates and withdrawal
patterns.” [Emphasis added.]
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Demographic Considerations
In a 2011 report on TDFs, the GAO observed:
“Plan sponsors and industry experts we spoke
to identified several key considerations in
selecting and monitoring TDFs, such as
ensuring the TDF fits with characteristics of the
workforce.”
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Asset Allocation and Glide Path
The ICI and ABC listed these considerations for
fiduciaries:
 What asset classes are used in the TDF to achieve
diversification?
 What is the glide path used by the TDF?
•
What is the TDF’s asset allocation when it is most
focused on growth?
•
What is the asset allocation at the target retirement
date?
•
At what point in time does the glide path reach its
final asset allocation?
continued . . .
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Prevailing Practices
Continued . . .
• What has been the investment performance not only
of the TDF but also of its component investments?
• What benchmarks are available to evaluate and
monitor the TDF’s investment performance? Do
these benchmarks address the performance of the
underlying investments as well as the performance
attributable to asset allocation?
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Focus on Older Participants
Asset Allocation and Glide Path:
“It is in the glide path where we see the most
fundamental differences between fund families. For
instance, do the managers believe their job is to
boost retirement account balances through
aggressive growth strategies, or do they believe their
job is more accurately stated by the Hippocratic
paraphrase, ‘First, lose no money?’ ”
--Popping the Hood II, An Analysis of Target Date Fund
Families, by Turnstone Advisory Group LLC
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The Fiduciary Process
The fiduciary process for selecting target date funds
involves:
• An analysis of the needs of the plan and the needs and
abilities of the participants.
• An analysis of the asset allocation.
• An analysis of the glide path.
• An analysis of its manager and its abilities and limitations.
• The qualitative and quantitative analysis generally used
for mutual funds, including reasonableness of expenses.
Target Date Funds  November 6, 2014
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TDF Distinctions
 Aggressive versus conservative (asset classes).
 Focus on last 10 years before the target date
(the “red zone”).
 “To” retirement or “through” retirement.
Query: What does the IPS say?
Target Date Funds  November 6, 2014
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Why Consider TDFs?
The DOL Tips say that fiduciaries should “inquire
about whether a custom or non-proprietary target
date fund would be a better fit” and that “a Custom
TDF may offer advantages” to plan participants.
Source: Tips for ERISA Plan Fiduciaries, U.S. DOL Employee
Benefits Security Administration, February 2013.
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Tips from DOL
“Plan fiduciaries are required to periodically review
the plan’s investment options to ensure that they
should continue to be offered. . . . if the fund’s
manager is not effectively carrying out the fund’s
stated investment strategy, then it may be necessary
to consider replacing the fund.”
Query: Do most plans have documentation of their
monitoring of TDFs?
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A Documented Process is Required
Moreover, DOL guidance notes that compliance with a
fiduciary’s duties requires that the steps taken in the
process must be adequately documented:
“It is the view of the Department that compliance
with the duty to monitor necessitates proper
documentation of the activities that are subject to
monitoring.” *
*Department of Labor, Federal Register Volume 72 (72 F.R. 60452,
60463).
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FRED REISH, ESQ.
1800 Century Park East, Suite 1500
Los Angeles, CA 90067
(310) 203-4047
(310) 229-1285 [fax]
[email protected]
www.linkedin.com/in/fredreish
www.drinkerbiddle.com
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