On Nov. 7, 2019, the Securities and Exchange Commission’s (SEC) Office of Compliance Inspections and Examinations (OCIE) issued a Risk Alert covering target date funds. The Risk Alert was based on the OCIE staff’s examination of over 30 target date fund series. It notes that they generally found good compliance among the investment managers they examined, but it highlighted a few compliance issues that they observed.
Specifically, the Risk Alert identifies two primary issues that OCIE staff observed:
“…incomplete and potentially misleading disclosures in their prospectuses and advertisements…” and “…incomplete or missing policies and procedures…”
The disclosure issues centered around funds marketing materials not matching their prospectuses with respect to asset allocation, glidepath changes, and potential conflicts of interest that arise from using affiliated funds within the target date fund series. The policies and procedure issues focus on monitoring asset allocation, implementing changes to glidepaths, and monitoring whether glidepath deviation disclosures are accurate.
The Risk Alert isn’t focused on plan fiduciaries use of target date funds within their plan investment menu, potentially as the Qualified Default Investment Alternative (QDIA), but it does serve as a helpful reminder to plan fiduciaries that they need to continue to monitor the target date fund series. For most plans, the target date fund series has become the single most important investment in the plan. Its use as a default investment option and the simplicity of its usage has enabled target date funds to become the largest and most widely used investment in many plans.
The simplicity of target date funds usage by participants is countered by the complexity of these investment vehicles from an oversight perspective. Target date funds’ complexity comes from the layers of investment decisions that each manager makes regarding their series. They have to create an investment glidepath, populate that glidepath with diversifying asset classes, and select investment strategies to populate each asset class within the portfolio. On an ongoing basis, they need to maintain a consistent allocation to their chosen glide path or choose to deviate in hopes of reducing risk and/or enhancing return through their tactical investment management decisions.
For plan fiduciaries, oversight of the target date fund series needs to be robust to understand and monitor the complexity that comes with their target date fund series. Prior to adding the series to the investment menu, you should complete a thorough analysis so you know what you are buying. That analysis should include the following:
- Understanding of the fund’s glidepath
- How much equity does the fund start with farthest from retirement?
- When does it begin to transition to a more fixed income?
- What is the equity / fixed income split at retirement?
- Does the glide path continue past the retirement date? If so, for how long and what is the terminal equity allocation?
- Which asset classes are included within the glidepath allocation?
- Which investment strategies are being used to manage allocations to each asset class?
- Is the strategy actively or passively managed?
- Is it a proprietary strategy of the fund manager?
- What are the track records of the underlying investment strategies?
- How much deviation from the glidepath will the funds experience?
- Why does the manager deviate from the glidepath allocation?
- Does the manager have a track record of adding value through their tactical asset allocation decisions?
Getting answers to these questions will give you a thorough understanding of how the investment manager intends to manage the target date funds and whether they are a right fit for your plan. Once the funds have been selected, you need to continue to monitor these products to confirm that they are adhering to the expectations that the manager set at the outset as well as to see whether the manager is implementing any changes to the funds that would impact your decision to include them in the investment menu.
Target date funds are not static products. They have evolved over time based on changes in capital markets, new research into participant behavior, and new investment management theories. Oversight and due diligence need to be ongoing to confirm that the products continue to be appropriate within your plan. As fiduciaries for the investment advice we provide, our investment team updates our qualitative due diligence every six months for the target date funds series that we utilize with our clients so that we can help clients stay informed and knowledgeable about the most important investment product within their investment menu.
Multnomah Group is a registered investment adviser, registered with the Securities and Exchange Commission. Any information contained herein or on Multnomah Group’s website is provided for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Multnomah Group does not provide legal or tax advice.