Speech by SEC Commissioner:
Combating Investors Misperceptions by Requiring Higher-Quality Disclosure
Commissioner Luis A. Aguilar
U.S. Securities and Exchange Commission
SEC Open Meeting
June 16, 2010
Target date funds had been hailed as “easy-does it, self-contained retirement portfolios for average investors.”1 After the events of 2008, it was a different story. Headlines reported that after the 2008 crisis, millions of individuals invested in 2010 target date funds received a jolting shock upon opening their account statements. This shock resulted in investors realizing that these funds often had a very different asset allocation than they had believed. Instead of the more conservative assets they expected, they found that they were far more exposed to equities than they had imagined. Moreover, investors and pundits alike were surprised to learn that different funds with the same retirement date had vastly different asset allocations.
This fundamental disconnect between investors’ expectation and the reality of the investment product raises serious concerns — and calls for the Commission to act. Investors require not just any disclosure, but high-quality disclosure that equips them to evaluate the fee, structure, and risks of the products they invest in. It is the Commission’s mandate and responsibility to equip investors with the tools they need to evaluate investment products.
I would like to concentrate my remarks by first, discussing the mix of factors leading to the situation that confronts us including: the size of the market, vulnerable investors, complex investment products, potentially confusing marketing campaigns, and billions in assets and fees at stake; and second, highlighting particular areas that I would like commenters to address.
The Size of the Market
First, let’s discuss the size of the problem. By the end of the 1990s, the assets in these funds totaled $10 billion. At the end of 2008, about 7.3 million people already held target date funds in their 401(k) accounts.2 By July 2009, four separate target-date fund series were larger than the entire industry had been a decade before. The assets of registered target date funds were estimated at $291 billion dollars as of May 2010.3
In addition, target date funds have become commonplace in 401(k) plans as a result of their designation as qualified default investment alternatives by the Department of Labor in 2006.4 Annual contributions soared in response — from $7 billion in 2003 to $35 billion in 2006. This designation virtually assures that the future financial security of a greater number of American worker and their families will be highly dependent on these products.
Next, let’s discuss the demographics of who is invested in target date funds. It is the American public and because of their growing use in 401(k) plans, target date funds have become an important component of the retirement assets that these Americans will rely on.
Target date funds have an attractive quality. After all, these are funds whose assets investors expect to be allocated more conservatively over time so that investors may believe that they have no need to monitor or adjust how their investment is allocated. Indeed, it is the relief from the need to actively monitor that draws many investors to these products. In today’s world of fewer company pension and defined benefit plans, investors are increasingly left on their own to create and implement their own retirement savings. Investors have complicated lives and a multitude of daily concerns thus, making them particularly vulnerable and susceptible to the promises of target date funds.
While target date funds have attributes that can make them valuable to investors — including putting investors without a basic retirement plan in a better place — it is important for the Commission and the industry to equip investors with the information and tools to be able to truly evaluate these products and be in a position to make an informed decision.
The Need for Clarity in Marketing Campaigns
Investors’ misperceptions about target date funds arise in part on the representations made in target date fund marketing campaigns. Many investors have been sold on the idea that choosing a target date fund based on the investor’s retirement date is the only criteria required — that these are “simple” investment products. One fund complex characterized this as investors going on “cruise control.” A financial columnist for the Washington Post, described target date funds as operating similar to the “‘set it and forget it’ machines that allow you to roast a chicken with little effort.” Unfortunately, that’s not the case.
Marketing campaigns, by and large, failed to inform investors about the structure of these funds, and the fact that funds sharing the same date can differ dramatically in asset allocation, and that target date funds, like any other investment product, can lose significant amounts of money.
Complex Investment Product
Although marketing campaigns gave investors the perception of simplicity, target date funds are much more complex than meets the eye.
No investment product is risk free. That lesson has been put in stark relief over the past two years and it is important that no investment product be sold as such. In addition, most target date funds employ a more complicated “fund of funds” structure where the target date fund invests in a pre-arranged mix of stock, bond, and money-market mutual funds, usually from the same fund family. This means that investors need to review these products to evaluate the underlying funds’ investment objectives and fee structure as well as the target date fund asset allocation and fee structure.
Billions in Assets and Fees at Stake
Exacerbating the harm flowing from the disconnect between investors’ perception and reality, is the sheer fact that investments in target date funds are being actively marketed and are aggressively growing. This is currently an explosive area of growth for the industry. Beyond the growth to date, a recent report estimates that target date funds could reach $880 billion in assets by 2015.5
All of the factors that I’ve mentioned underscore the need for the Commission to act. Today’s proposal is a step toward injecting greater clarity and transparency into the process and moving toward a body of marketing material that makes it clear to investors that no two target date funds are exactly alike and that, in fact, the variation among similar funds can be dramatic.
I look forward to comments on today’s proposal, and I am particularly interested in comments highlighting any issues or potential Commission actions that our proposals do not include that could significantly benefit investors in target date funds.
I would also like to hear from commenters on how the Commission’s summary prospectus initiative can be best used to right the misperceptions held by target date investors. I know fund complexes are in the midst of implementing the summary prospectus initiative and I would ask that they pay special attention to how to best put these documents in the hands of target date fund investors. I am particularly concerned about investors who own these funds through their 401(k) plans and look forward to our staff continuing to work with staff at the Department of Labor to make sure that the summary prospectus is being put to its best use for investors. I am also interested in feedback from commenters as this initiative continues to be implemented.
Given the importance of target date funds to investors, who are increasingly left on their own to ensure their financial security in retirement, the Commission simply must ensure that investors have the information and the tools they need to invest in these funds wisely.
As I end my remarks, I join my colleagues in thanking the staff for the hard work that is reflected in the recommendations before us.
1 M.P. Dunleavey, “Some Target Date Funds Adjusting After Criticism.” New York Times, April 9, 2010.
3 Morningstar, Morningstar Direct Fund Flows Update (May 2010). available at http://corporate.morningstar.com/us/documents/FundFlows/FundFlowsMay2010.pdf.
4 The qualified default investment alternative (QDIA) provides liability protection for an employer who sponsors a defined contribution plan and places contribution of those plan participants who have not made an investment choice into a target date fund or other QDIA.
5 Janet P. Levaux, “Vanguard Adds Target-Date Fund, Giving Fund Giant 12 Lifecycle Funds.” Investment Advisor, available at http://www.investmentadvisor.com/news/2010/6/Pages/Vanguard-Adds-TargetDate-Fund-Giving-Fund-Giant-12-Lifecyle-Funds.aspx (citing Lynette Dewitt, Financial Research Corporation, Rethinking Lifecycle Funds – Targeting a Retirement Solution)