SEC Reconsiders TDF Glide Path Illustrations

The rule amendments would, if adopted as originally proposed, require marketing materials for TDFs to include a table, chart or graph depicting the fund’s asset allocation over time—i.e. an illustration of the fund’s so-called asset allocation “glide path.” SEC officials hope the reopened comment period will generate additional input on the question of whether such illustrations would be helpful to new and inexperienced investors and how difficult they would be to deliver for service providers.

SEC officials also hope to test the industry’s response 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 glide path illustration that factors in important risk considerations—not just asset allocation over time.

The SEC feels many investors have misconceptions about TDF products, some of which may be cleared up by mandating glide path illustrations. For instance, investors often believe their fund’s target date is the point at which the asset allocation stops changing. Others believe the target date is the point at which the fund is at its most conservative allocation, the SEC says, but neither of these facts is necessarily true, depending on whether the TDF is a designed as a “to” or “through” fund.

The bifurcation of actively managed TDFs and those with an index-based approach also challenges investors, the SEC says, and a host of hybrid products have come to market that may be causing confusion (see “Can You Really Set It and Forget It?”).

The SEC’s Investor Advisory Committee says much of the differences in risk among TDFs can be explained by differences in asset allocation models and glide paths, so mandating glide path illustrations is clearly important. But the committee also warns that more specific investment philosophies and choices made by individual managers within the various asset classes have a significant impact on fund risk and return levels. In addition, the Investor Advisory Committee feels asset allocation information may even be used to mask differences in the risk levels of funds with apparently similar or even identical asset allocations glide paths, particularly when asset classes are broadly defined.

The advisory committee therefore opined that a glide path illustration should be based on a standardized measure of fund risk that would be more accurate than an illustration based on asset allocation alone. The committee has not developed a particular risk measure or methodology that would underlie this type of risk-based glide path analysis. Instead, the committee recommended that the wider SEC should include factors such as volatility of returns or maximum exposure to loss in its rules on glide path illustrations.

The SEC is inviting a new round of comments on this debate—whether a standardized and risk-based glide path illustration is necessary to protect investors utilizing TDFs, or whether a simpler asset allocation guide is sufficient—and on any other aspects of the recommendations and other matters that may have an effect on either proposal.

One specific question being asked by the SEC is if the originally proposed disclosure of asset allocation, which is not based on a standardized measure of risk, would be enough to effectively convey the level of a fund’s investment risk—or if a standardized measure is, in fact, needed. Another matter being considered by the SEC is whether the emphasis on asset allocation might cause investors to prioritize investment risk over longevity risk, inflation risk, or other risks. Also of concern is whether TDF managers do or do not systematically take on more risk than the asset allocation would reflect to novice investors.

Comments may be submitted by any of the following methods:

• Electronic comments — Use the SEC’s Internet comment form at http://www.sec.gov/rules/proposed.shtml or send an email to rule-comments@sec.gov, including “File No. S7-12-10” in the subject line. Commenters can also use the Federal eRulemaking Portal at http://www.regulations.gov.
• Paper comments — Send paper comments to Secretary, Securities and Exchange Commission, 100 F Street, NE, Washington, D.C. 20549-1090.

A full list of the SEC’s questions and more information about the various proposals on TDF marketing is available here.