Following the poor performance of target-date retirement funds in 2008 - Ibbotson Associates reports the average 2010 fund dropped 23% - a mid-June hearing sponsored by the Department of Labor and Securities and Exchange Commission gave voice to the growing debate on whether or not the funds should be subject to increased federal regulation.

Although panelists at the day-long hearing in the nation's capital generally agreed that additional disclosure and participant education would help to clear up confusion and remedy gaps in public understanding about target-date funds, many pointed out that a target-date fund is most attractive to an investor who does not want to be actively engaged in the management of the retirement fund.

The funds have become an increasingly popular option for investors who are attracted by what SEC Chairwoman Mary Schapiro described as their "set it and forget it" nature.

The varied opinions on optimal asset allocation at the target date, as well as glide-path projections, indicate there is no one-size-fits-all target-date fund, and many who testified insisted there is no need for the government to enact asset allocation mandates.

Same year, different spread

Allison Klausner of Honeywell International, who represented the American Benefits Council at the joint hearing, emphasized the need for "plan fiduciaries to have the flexibility to determine the appropriate offering for its plan participants based on the information obtained from its due diligence."

One common criticism of target-date funds is that they can vary widely even if two different funds are labeled with the same year, depending on the construction of asset allocation and equity exposure. "There is wide variation in the risk profiles of the target-retirement-date funds in the marketplace." says Howard Biggs, managing director of retirement plan consulting for Arnerich Massena.

Some of the alarm surrounding the performance of 2010 funds comes from a lack of understanding on the part of participants and plan sponsors of their asset allocation, says Charles Nelson, president of Great-West Retirement Services. "The issue around some of the 2010 funds is really the understanding of the participants and the plan sponsor of what the asset allocation was going to be for a 2010 fund," he says. "I think some plan sponsors in certain situations may not have had a thorough understanding of the glide path and the issues of really what they were investing in maybe as much as they should have."

When participants think about target-date funds, "they expect an appropriate reduction of equity risk exposure as they approach retirement and do not expect to have significant losses in the years right before retirement. They expect that they will be protected from significant downside risk," adds Biggs. "The actual implementation of these products has exposed participants to much greater risk than they may have expected."

Keep on educating

It's up to all of the constituents involved in a target-date fund - the plan sponsor, adviser and participant - to have ownership in researching and understanding potential glide paths a particular fund can take and whether or not they will meet the demographic needs of the employer and investor, says Nelson. Areas to consider when choosing funds include employees' average age, tenure, income, company turnover rates and whether or not a defined benefit plan is also included.

"Oftentimes I think plan sponsors and advisers just select based off returns, which can be a very narrow viewpoint of really what the target date's all about," says Nelson.

Ever since DOL approved target-date funds as a qualified default investment alternative in 2007, plan sponsors need to be aware that QDIA target-date funds are naturally going to be monitored less by employees, as they are not actively engaged in researching and choosing the investment funds.

"It would be a common expectation that participants who are defaulted into target-retirement-date funds through a QDIA would be less active or engaged investors, and are relying on the product to appropriately manage their risk," says Biggs.

Even so, it remains the responsibility of the plan sponsor to communicate the risk profile and glide path to employee participants through comprehensive education programs that include product literature and educational seminars, available either electronically or in person.

Education is needed "at the plan level, particularly around the risk profiles and possible range of return outcomes of the various target dates for the product that the plan has implemented," says Biggs.

Already regulated

As for introducing new target-date regulations, Nelson says it's not necessary because the SEC and Financial Industry Regulatory Authority already provide "plenty" of regulations to ensure plan information is clearly communicated. "Now unfortunately, I think sometimes participants and plan sponsors don't take the time to read the material available to them as thoroughly as maybe all of us hope and believe that they should," he adds.

Advisers may be able to help overcome this behavioral obstacle, Nelson says, by simplifying the key points and more salient issues involved with target-date funds. "So I would be not for more regulation on target dates, but maybe more responsibility on plan sponsors, participants to read the materials that are available to them today," he says.

Biggs believes target-date funds will continue to be a useful retirement savings tool and wouldn't be surprised to see more regulations develop around QDIA safe-harbor requirements. "It makes sense that there would be some limitation around the upper-end risk levels for target retirement date funds within the QDIA construct," he says.

Like any other type of investment, Biggs adds, "I don't expect the products themselves to be regulated in such a way to eliminate market risk. But it may make sense in providing QDIA safe-harbor structures to place some limitations on the risk profiles or upper-end equity exposure of target-retirement-date funds to mitigate or protect against large losses as participants near retirement," he says.