5 Criticisms of the GAO Report on Target Date Funds

Last month, the Government Accountability Office (GAO) released 401(k) Retirement Plans: Labor Department Should Update Guidance on Target Date Funds in response to a May 2021 request from Senator Patty Murray (D-WA), Chairwoman of Health, Education, Labor and Committee on Pensions (HELP), and Rep. Bobby Scott (D-VA), Chairman of the House Education and Labor Committee.

The GAO report took 3 years to complete. At $4 trillion and growing, TDFs are very large. The GAO report has the potential to improve the industry.

Congressmen Murray and Scott wrote:

“…we write to request that the Government Accountability Office (GAO) conduct a review of Target Date Funds (TDF). The employer-provided retirement system must effectively serve its participants and retirees, and we are concerned that certain aspects TDFs could place them in danger.

…According to The New York Times, “For example, many of the leading target date funds designed for people retiring in 2020 have 50-55% of their investments in stock funds…. Meanwhile, the Thrift Savings Plan 2020 Lifecycle Fund had over 60% allocated to the G Fund (short-term U.S. Treasury securities) for the two years prior to its withdrawal.

They distinguish the Federal Thrift Savings Plan (TSP) as an example of a plan that has weathered market turbulence well. With six million beneficiaries and $800 billion in assets, the TSP is the the largest defined contribution plan in the world.

And as a federal plan, Congress should at least consider the TSP’s target date funds, called “L Funds.” It is important to note that GAO employees participate in the TSP.

GAO recommends that DOL intensify its review of TDFs as follows:

GAO recommends that DOL update (1) its 2013 guidance for plan sponsors and (2) its 2010 guidance for plan participants on the selection of TDFs. The DOL disagrees with both recommendations. GAO continues to believe both are justified, as noted in the report.

Here are five critiques of the GAO report that constitute specific recommendations to all TDF regulators, including the DOL.

1) The risk as the target date approaches is much higher than it should be

As requested, GAO compares the risk of TSP to that of the TDF industry, as shown in the following 2 charts. The TDF say they follow academic theory of lifetime investmentbut most do not follow the theory explained in This item. The theory is 80% risk-free by the target date, but the industry is 90% risky throughout (at any age) in risky stocks and long-term bonds.

The TSP follows the theory. It is very safe on the target date, with 70% of the risk-free G fund guaranteed against loss by the US government.

Regulators should know that academic theory is very safe for those near retirement, and they should call out the industry for lying about following the theory. This deviation from theory has been rewarded over the past 15 years as U.S. stocks have enjoyed their longest bull market ever, but that will change. High risk will suffer high losses in the next stock market crash; This is the nature of risk.

Congressmen Murray and Scott have expressed concern about the level of risk of TDFs. The study accepts industry risk without questioning why it is superior to TSP and academic theory. An important opportunity to improve TDFs should not be missed.

2) There is a more meaningful distinction than “To” and “Through”

The GAO report uses the distinction “To” and “Through” throughout. Although this is a popular approach, it is a distinction without a difference. Safe versus risky on the target date makes much more sense, as explained in A more meaningful choice of target date funds than “until” or “until”.

3) TDF collective investment funds must be scrutinized

The GAO report focuses on mutual fund TDFs, but it believes that CIT TDFs may not be as well understood as they should be. The GAO report says:

“Without guidance on reviewing TDF’s mutual fund information, including written plans and mutual fund fact sheets, plan sponsors may not understand the fund information collective investment schemes that they should use as part of their TDF selection and monitoring process.”

Also in Commentary: Fiduciary risks of target date funds, Chris Tobe warns:

There is a general assumption that CITs are regulated by the Federal Currency Comptroller’s Office. Some CITs are regulated by the OCC, while most used in 401(k)s are regulated by one of 50 state banking regulators. This allows corporations to choose their own state regulator, who may or may not exercise lax oversight. Although the SEC’s mutual fund regulations aren’t perfect, they control many risks and provide a fair amount of transparency.

Trustees should review CIT TDF reports and understand the details. They are not regulated by the SEC. For example, expenses reported for the underlying funds must be reviewed and evaluated.

4) There is only one demographic that really matters

The GAO reports that advisors place great importance on workforce demographics in their selection process, but there is only one demographic element that all defaulting participants have in common – lack of financial sophistication – and this demographic factor makes them look like our dependent children. Duty of care is akin to our responsibility to protect our young children from avoidable harm. Defaulting participants deserve and need protection.

5) The interests of the participants do not match those of those who were interviewed for the study

GAO interviewed management companies and advisors. Both are happy with the status quo, but the current structure is not best for participants, as noted in Final DOL Fiduciary Rules Could Resolve Conflicting Interests in Target Date Funds.

GAO did not interview participants. Other participant surveys indicate that participants want to be protected when they retire, and most believe they are protected. Defaulting participants do not choose TDFs; their trustees choose for them. Also remember that GAO employees participate in the TSP and the TSP TDF actually follows academic theory – it protects.

There are three interest groups within the TDF. Investment managers create TDFs for profit, which is after all their job. The trustees choose TDFs, presumably for the benefit of the participants, but that is not what happens. Beneficiaries want to be protected, particularly when they enter retirement, but they are in reality exposed to significant risks.

Conclusion

78 million baby boomers will spend this decade in the retirement risk zone, as losses can devastate the rest of their lives. Many are invested in the $4 trillion TDF industry and will be significantly affected by an accident during this decade.

Recommendations for greater surveillance should be taken seriously and implemented quickly.