Industry Responses Vary on TDF Disclosure Proposals

As Securities and Exchange Commission (SEC) Chair Mary Jo White explained during a brief address preceding a recent SEC Investor Advisory Committee meeting, commenters have generally favored “appropriately tailored enhanced disclosure requirements for target-date fund marketing materials.” However, a number of commenters expressed concerns that standardized risk measures called for in the proposal are likely to confuse or mislead investors—while still others supported the proposal in full, citing the potential usefulness of a standardized risk measure for use target-date fund (TDF) benchmarking.

The original proposal covers a variety of potential changes that the SEC says would improve investors’ understanding of TDFs. For example, the rule amendments would require marketing materials for TDFs to include a table, chart or graph depicting the fund’s asset allocation changes over time—i.e. an illustration of the fund’s so-called asset allocation “glide path.”

SEC officials also hoped the reopened comment period could generate responses to a new question coming out of a 2013 proposal from the SEC’s Investor Advisory Committee, which urges the full SEC to take the additional and more challenging step of requiring a standardized TDF glide path illustration that factors in important risk considerations—not just asset allocation over time. SEC officials believe that to be truly helpful as a benchmarking and comparison tool, glide path illustrations should be based on a standardized measure of fund risk that would be more informative than an illustration based on asset allocation alone.

White added that the Department of Labor has also proposed to amend TDF disclosures and require a glide path illustration for target-date funds subject to Employee Retirement Income Security Act (ERISA) oversight. The comment period for that initiative also closed earlier this month.

“[The SEC] staff is carefully considering the comment letters we received and will coordinate with the Department of Labor on our respective initiatives, as appropriate,” White said.

A full list of the comment letters, including the text of the comments and the dates they were received, is available on the SEC’s website. Industry responses were varied in both style and substance—from one paragraph statements of a general distrust for expanded disclosure requirements to lengthy analyses of whether risk glide path disclosure should be required for TDFs that have no official target level of risk.

For example, Lincoln Investment Advisors Corporation submitted a comment letter that urges the SEC to distinguish between disclosures of target-risk levels and disclosures based on projections of risk based on historical performance (whether of the fund or of asset classes). A target-risk glide path, according to Daniel Hayes, vice president and head of funds management for Lincoln Investment Advisors, shows how the explicit target risk of the fund will change over time. In contrast, a “projected-risk” glide path would be a projection of the fund’s risk based on the historical behavior of the asset classes the fund plans to own.

“A projected-risk glide path is inherently conjectural, and does not tell investors anything about how the fund will actually be managed,” Hayes warns. “Risk, in the sense of historical volatility, is a performance metric. The Commission has for decades prohibited disclosure of performance projections, and with good reason. Investors can easily be misled by performance projections, and this problem generally cannot be adequately addressed by disclaimers explaining the conjectural nature of the projections.”

Projected-risk glide paths would thus risk misleading investors without providing useful information, Hayes says, adding, “With investors already confused about the nature of target-date funds, the Commission should continue to prohibit performance projections, including projections of risk.”

Charles Miller, a Wilmette, Illinois-based financial services communication consultant, argues in another letter that increased disclosures could actually have an adverse effect on novice investors. He makes the age-old argument that participants in retirement plans are already given much more information than they can digest, and every measure of increased disclosure will require some amount of education to actually impact real investors.

“Instead of a simple glide path illustration of the equity/debt percentages, I suggest a graph with five-year ‘waypoints’ that show not only the classes but also the types of equity and debt, and a simple description of risk,” Miller suggests. “You would have your glide path when you connect the waypoints.”

Stephen M Batzza, chief executive officer at MTL Insurance Company, shared a similar opinion, but he says he generally supports the SEC’s effort to make TDFs more transparent. “My initial reaction is that a risk-based illustration may create more confusion than enlightenment,” he writes. “With that said, it would be beneficial to see an example of what such an illustration would look like. The level of its complexity may determine whether such a disclosure is worthwhile.”

Louis Harvey, president and CEO of DALBAR Inc., shared one of the longest comment letters, about 40 pages in all. Harvey says he agrees with the SEC that it is in the best interests of retirement plan participants to develop a simplified system that allows people to understand the “true purpose” of a given TDF. That said, he doesn’t believe people who aren’t sophisticated with finance should be expected to decipher complex charts and other forms of data.

“We need to develop guidelines for TDF names and marketing that facilitate effective communication to that group,” he writes.

Many of the industry concerns shared during the recent comment period had also been raised in 2010 and 2011 after the original release of the proposed SEC rule change (see “Charts and Graphs are Good, but Don’t Change Fund Names”). For instance, Chip Castille, managing director and head of BlackRock's U.S. Retirement Group, commented that what is most important for retirement investors to understand is how asset allocation changes over time, and disclosure of this information via a graph or chart would, as the SEC suggests, permit investors to visualize the glide path in relation to their own time horizon.

BlackRock and others suggested that text accompanying the chart should state explicitly that the asset allocation could change from what the chart illustrates based on changes in the managers' assumptions as to retirement readiness, longevity and market risk. Further, the disclosures should also state what types of investments are included in each asset class, Castille said, and investors should be specifically informed that investments in TDFs, like all investments in securities, are not guaranteed. Like many of the recent commenters, Castille warned the SEC to be cautious not to require so much information that DC plan participants are overwhelmed and thereby distracted from making sound decisions about their retirement assets.

Others suggested that target-date fund providers should be impelled to include the table of data from which they derive their glide path graphics, saying supplying one without the other makes it difficult to accurately compare multiple TDF series. Morningstar, for example, suggested that the SEC require further disclosures of a fund’s intended sub-asset class allocation within broader asset classes, based on the understanding that two funds with identical equity-bond-cash allocations may have very different risk profiles depending on the underlying holdings.