The Certified Financial Planner Board of Standards has recommended enhancements to the Securities and Exchange Commissions proposed rules in target date funds, including better disclosure in the funds advertising and marketing materials.
The SEC has been soliciting comments on its proposed rules for the funds, which have become a popular investment choice for many 401(k) and mutual funds, and often the default choice of many retirement plan administrators. However, many of the target date funds, which are tailored to people who plan to retire by a certain year, performed comparatively poorly during the financial crisis, and often had high administrative costs.
The CFP Board recommended that the funds provide better disclosure in their ads and marketing materials, more specific information about their glide path and asset allocation, and greater descriptions of asset classes.
With their easy to understand names and their marketing, many investors incorrectly believe target date funds are simple investment solutions, said CFP Board CEO Kevin R. Keller in a statement. They do not realize that target date funds are generally managed to account for factors other than stability of principal approaching the retirement date, including time horizon, risk aversion, longevity risk, and inflation risk. The SECs proposals do not go far enough to explain to investors that many funds are managed in ways different from those investors may reasonably expect.
The CFP Boards letter came in response to the SECs comment period on the proposed amendments to rule 482 under the Securities Act of 1933 and rule 34b-1 under the Investment Company Act of 1940.
The CFP Board, while commending the SEC for taking action to address the issue of target date funds, made recommendations for additional investor protections that fall into three key areas:
1. Information about Volatility Risk: A target date fund should make clear and prominent disclosures alerting investors when a target date funds equity allocation differs materially from the average allocations of peer funds with the same target date. The SECs proposal would require disclosure of the asset allocation at the target date along with the first use of a funds name.
The CFP Board recommended the SEC go one step further and require funds to identify the average target equity allocation for all target date funds with the same target date and disclose the extent to which its target equity allocation differs from the average. The SECs proposal would also require a visual depiction of a funds glide path. The CFP Board recommended that the SEC require target date funds to provide a graphical comparison of the average glide path for all target date funds with the same target date along with the funds stated glide path.
2. Information about the Glide Path and Asset Allocation: A target date funds disclosures must be aimed at enhanced understanding of a target date funds glide path and asset allocation at the target date and landing point. Specifically, the CFP Board recommended that the SEC require sufficient disclosures to allow investors to know whether the glide path is designed to extend to or through the target date, including a narrative statement immediately following the required disclosure of the funds asset allocation and a table, chart or graph that visually depicts the glide path.
3. Information about Asset Sub-Classes: A target date fund should disclose additional information about specific asset sub-classes in which it invests. The CFP Board expressed concern that the broad asset classes of equity, fixed income, and cash are so broad that they do not communicate sufficient information about a funds actual asset allocation, investments, and risks.
These recommendations will effectively alert investors to the level of investment risk presented by a particular target date fund. Simply disclosing a funds asset allocation without providing a baseline from which to compare to other funds fails to provide meaningful investor protection, said Keller. "Disclosing only the broad asset classes in which two target date funds invest may not convey the level of investment risk presented where they follow different investment strategies within a broader asset class.
The CFP Board also recommended that the SEC:
* Require a statement suggesting that investors periodically revisit whether a fund remains an appropriate investment given particular circumstances and needs;
* Require disclosure of whether, and the extent to which, the intended asset allocations can be modified without a shareholder vote;
* Require a description of the glide path, the significance of specific points along the glide path, the investment advisers flexibility to deviate from the glide path, and specific risks of investing in target date funds in the prospectus and summary prospectus;
* Require clear disclosure of how ranges of potential percentages operate in the prospectus and summary prospectus;
* Require disclosure of the underlying assumptions used in developing a target date funds glide path, including life expectancy, inflation, savings rate, other investments, additional retirement income, and withdrawal rates in the prospectus and summary prospectus;
* Require shareholder reports to include a comparison of the funds performance to the median performance of peer funds with the same target date;
* Conduct focus groups and surveys of investors to assess the effect the proposed disclosures might have on investor behavior; and,
* Work with its Office of Investor Education and Advocacy and the Department of Labor to explore more appropriate means of educating investors about target date funds.
Target date funds are increasingly being used as the retirement vehicle of choice particularly for less engaged or sophisticated investors who are looking for an auto pilot investment that is tied to their date of retirement, Keller said. If a target date fund is managed in a way that is not consistent with the reasonable expectations of investors that funds will be available as of the target date, this needs to be clearly and effectively disclosed to investors.
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