A Lawsuit Waiting To Happen: A Popular Default Investment In 401(k)s Exposes Advisors, Fiduciaries, And Plan Participants To Unexpected Risk

Thursday, September 15, 2011 11:31
A Lawsuit Waiting To Happen: A Popular Default Investment In 401(k)s Exposes Advisors, Fiduciaries, And Plan Participants To Unexpected Risk

Tags: 401(k) | fiduciaries

Target Date Funds (TDFs), probably the most popular default investment in American 401(k) plans, may be an accident waiting to happen. 

TDFs are supposed to be a simple solution for plan participants. But they’re fraught with problems in the way they are being sold, and it could spawn lawsuits in the next bear market.
The way TDFs are supposed to work and are positioned with investors is simple: If you’re retiring in 2025, a TDF will provide you with a lot more equity-risk exposure than a TDF targeted to someone retiring in 2015. A plan participant just picks a TDF suited to his retirement date and lets the fund company make the asset allocation decisions for his retirement fund.
However, many target date funds with the same exact retirement target date follow widely divergent investment strategies, undermining the simplicity these funds are supposed to provide and for which they are purchased by those about to retire.
For example, says Ron Surz, an investment manager due diligence expert Alliance Bernstein, a venerable firm known for its equities research, has far more equity exposure in its TDFs than Bill Gross’ PIMCO Funds.
“PIMCO has the most conservative asset allocation and holds more bonds than any other TDFs,” says Surz, while the most aggressive glide path is Alliance Bernstein, which has little expertise in bonds.”
Surz says TDFs are products and not solutions, but they are not sold that way, which makes them more likely to spawn lawsuits against fiduciaries in the next bear market.
In the 2008 bear market, according to Ibbotson Associates, the 31 TDFs for individuals with a 2010 retirement date lost an average of 23.3% of their value, and the “2010 TDFs” with greatest equity exposure lost up to 41.3% of its value.
In early 2008, a person a 60- or 65-year old who was about to retire and who had invested in the average TDF with a 2010 retirement date, is likely to have never envisioned the possibility of losing 21.3% of his retirment savings—never mind losing 41% of his nest egg. He thought the TDF was making his asset allocation decisions and would act prudently.
Surz says class action attorneys were unprepared for the losses sustained by TDFs in the last bear market but that they will be prepared for the next bear market. He says fiduciaries need to examine TDFs more closely and look at ways to help protect 401(k) participants and plan sponsors from unexpected risks posed by TDFs.

Surz, a contributor on A4A, is leading a webinar today on this topic. Register here.  
Within 24 hours of the webinar, we should have the replay avaiable to A4A members and will be good for CFP and IMCA CE credit.


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Comments (6)

I have been wary of TDF's for years for exactly these reasons. It amazes me that professional investment advisors are willing to put the decisions in the hands of the TDF manager for asset allocation and then have the nerve to charge an AUM fee for doing that.

This truly is a giant lawsuit just waiting to happen.
cfp4me , September 15, 2011
Surz mentioned this to me: suppose you have a 50 year old with a $10 million trust fund and another 50 year with no trust fund and both are in a 401(k) plan with a 2025 target date fund. They will both be placed in the 2025 TDF even though they have totally different risk tolerance levels.
agluck , September 15, 2011
Coincidentally, because of these types of funds, a client recently requested an enhancement for SmartOffice to allow her to assign multiple asset classes and % allocations for a single security in our security master. Are there any other systems that allow an allocation breakdown for a single security?
steveambuul , September 15, 2011
Presumably plan participants receive disclosure from the advisor that they may reallocate funds to any option in the plan whether it be fixed rate with no risk, equity funds with more risk, etc. The balancing act is defaulting participants into less risky assets and "fearing" a bull market or defaulting them (older participants) to an tdf or other vehicle with more equity exposure and "fearing" a bear market. Lets educate participants on there choice and quit playing 'frady cat to the dogs with a law degree.
kmccarthy , September 15, 2011
Please remember that most participants in TDFs are defaulted into them. Accordingly they are employer-directed -- selected by fiduciaries, NOT beneficiaries. The outcry for better beneficiary education is healthy, but not applicable to default investments. Some participants simply can't make a decision. They trust their employers to do what is right, especially to protect them as the target date nears. The Big 3 TDFs -- Vanguard, T. Rowe & Fidelity -- are 45-70% in equities at target date. MUCH too risky in my opinion
ronsurz , September 16, 2011
Good comments. TDF's assume all employees have the same risk tolerances.
gsanford , September 18, 2011

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