July 21, 2009

Use of Target Date Funds in Qualified Retirement Plans:

 - A primer, plus the questions fiduciaries should be asking

By: Tom Bowler, Chief Investment Strategist, PrimeTRUST Advisors

Due to their seemingly intuitive asset allocation process, target date funds have emerged as a dominant fixture in the 401(k) landscape in recent years. This trendy, relatively new style of mutual funds is the marketed solution to simplify the investment decision-making process for 401(k) participants often overwhelmed and confused by the number and type of investment choices.

In addition, the Pension Protection Act of 2006 (PPA) provided a boost in popularity for target date funds when it included new fiduciary protections for plan sponsors of 401(k) plans using so-called Qualified Default Investment Alternatives (QDIA). How so? Target date funds are generally considered to be an eligible QDIA choice and clearly appear to be a very popular choice among plan sponsors.

However, the dramatic market losses incurred in 2008 have caught the attention of many plan sponsors, congressional leaders, regulatory agencies and litigators, bringing to light several troublesome realities in dealing with these funds:

1. The market risks for some of these funds are very often not fully understood by investment committee members responsible for including them in the 401(k) plan as an investment choice,

2. The due diligence requirements imposed upon fiduciaries for these investment products are subject to the same selection and monitoring processes as other investments offered within a Plan, and

3. Target date funds differ dramatically from fund family to fund family in their respective approaches to product design, inclusion of underlying investment styles, asset allocation, product fees, and risk management; accordingly, investment returns vary widely as well… leaving 401(k) participants bewildered and mystified.

According to data obtained from Morningstar, Inc., the investment returns for the target date funds (series 2000 to 2010) for the trailing twelve month period ending April 30, 2009 ranged from -5.39% to a dreadful -39.58%!!