The U.S. Securities and Exchange Commission (SEC or Commission) on April 3, 2014, reopened the period for public comment on its proposed target date fund (TDF) rulemaking.1 The Commission’s proposed TDF rulemaking (Proposal) would require certain TDF marketing materials to include, among other things, a table, chart or graph depicting the fund’s asset allocation over time – i.e., an illustration of the fund’s “asset allocation glide path."2 In connection with the Proposal, the Investor Advisory Committee (IAC), a body established by the Dodd-Frank Wall Street Reform and Consumer Protection Act, provided a number of recommendations to the Commission concerning the illustration of glide paths intended to provide enhanced information to investors regarding TDFs and reduce the potential for investors to be confused or misled by such investments. This DechertOnPoint summarizes the IAC’s recommendations concerning the risk-based illustration of glide paths and discusses the Commission’s request for comments.
TDFs permit investors to leave asset allocation and portfolio diversification decisions to professional portfolio managers. TDFs have become a popular investment option for retirement plans, at least in part because of the inclusion of such funds as “qualified default investment alternatives” (QDIAs)3 for so-called “Section 404(c)” retirement plans. One unique feature of a TDF is the fund’s “glide path,” a schedule by which the TDF’s asset allocation is adjusted with the goal of reducing risk exposure as the fund nears its target date. In light of the potential for investment losses even in asset classes generally considered less risky, such as during the market losses in 2008, and the increasingly popular use of TDFs in retirement plans, there is growing concern that investors may not fully understand the features of a TDF and its associated investment strategies and risks.4
One of the ways in which the Commission proposes to address these concerns is to increase disclosure requirements for TDF marketing materials. By request from the Commission, the IAC recommended that the Commission develop a glide path illustration based on a standardized measure of fund risk as either a replacement for, or supplement to, the proposed asset allocation glide path illustration.5 The IAC also recommended that the Commission adopt a standard methodology or methodologies to be used in the risk-based glide path illustration. The SEC reopened the Proposal’s public comment period so that these recommendations and other items pertaining to the Proposal could be addressed.
The IAC’s recommendation that the Commission develop a glide path illustration based on a standardized measure of fund risk was based on the IAC’s view that, while many of the differences between TDFs can be explained by differences in asset allocation models and glide paths, a TDF’s choices of assets within various asset classes and other risk management practices also have a significant impact on TDF risks. Moreover, the IAC stated that TDFs with similar or the same asset allocations may differ markedly in risk levels, particularly where asset classes are broadly defined. In order to promote comparability among TDFs, the IAC recommended that risk-based glide path illustrations be based on a standardized measure of risk. Although the IAC did not recommend a specific risk measure, it suggested that volatility of returns and maximum exposure to loss are relevant considerations.
SEC’s Request for Comment
The SEC’s request for comment raised a number of specific questions related to the IAC’s recommendations and, more generally, the Proposal:
- Management of Target Date Funds According to Risk. The SEC requested comments on several questions concerning whether asset allocation or risk management, or a combination of both, is the primary consideration in managing TDFs.
- Usefulness and Understandability of Risk Measures. The SEC also requested comments on a number of questions pertaining to whether there are quantitative risk measures that would be useful and understandable to investors in the context of the IAC’s recommendation.
- Illustration of Risk Measures. The SEC sought comments on questions concerning particular aspects of the IAC’s recommendation. For example, in addition to asking generally whether the IAC’s recommendation should be adopted, the Commission asked (among a number of other questions) whether an asset allocation glide path illustration alone would be sufficient and under what conditions, whether a risk-based glide path illustration should be required for all or only certain TDFs, and whether a risk-based glide path illustration should be backward-looking (showing past actual risk measures) or forward-looking (showing projected risk targets).
- Placement of Risk-Based Glide Path Illustration. The SEC requested comments on which TDF marketing materials, if any, were appropriate for required inclusion of a risk-based glide path illustration.
- Calculation of Risk Measures. The SEC also sought comments on whether required risk measures (if adopted) should be based on a standardized methodology or methodologies developed by the Commission.
- Impact on Investors. The SEC requested comments on whether TDF investors would be likely to understand risk measures and related illustrations, how investor behavior would be affected by disclosure of a particular risk measure, whether forward-looking disclosures (such as projected future volatility or other risk measures) would give rise to liability concerns and a number of related questions.
- Effects on Portfolio Management. The SEC sought comments on whether, and how, requiring disclosure of a quantitative risk measure or risk-based glide path might influence portfolio management.
- Benefits and Costs. Finally, the SEC requested comments on the benefits and costs associated with the IAC’s recommendation.
The comment period will remain open until June 9, 2014.