The retirement-fund business is reeling from huge mutual-fund losses and investor withdrawals. Fund executives point to overall market declines to defend their performance. They have logical explanations for the big losses suffered by one of their "safest" product classes--target-date mutual funds, which are designed as age-appropriate portfolios to help investors achieve their retirement goals. But a growing chorus of government, academic, and consumer critics is calling for changes in how the funds operate. And the fund companies themselves are under mounting financial pressures. Here are changes to look for:
More regulation. Democratic Senator Herb Kohl of Wisconsin, chair of the Senate Committee on Aging, is exploring tougher oversight of target-date funds. New retirement plan rules adopted in 2006 led to higher employee participation in 401(k)'s and other retirement plans, including the use of target-date funds as default investment choices. However, many investors were stunned when funds designed for 2010 retirees fell an average of about 25 percent last year. The marketing mantra of these funds was their automatic re-weighting as their owners aged--away from stocks and into bonds and other safer investments. Fund executives explain that someone retiring in 2010 may live another 30 years and will a solid chunk of equities in a target-date fund. But that truth never had a chance to catch up with public perception that safe means just that--no losses. As with the rest of Wall Street, the fund industry has taken a big consumer-confidence hit and may have to stomach more government rules to help win back investors. In the House Committee on Education & Labor, chairman Rep. George Miller of California has held multiple hearings with lots of venting at mutual funds. New rules here could include forcing the funds to disclose more details about their fees and more oversight of their communications with investors through employer retirement programs.
Automatic-pilot funds. Expect more retirement programs to steer employee and retiree money into index and other match-the-market funds that automatically adjust portfolios. Research findings agree that investors in 401(k), IRA, and other retirement programs make poor investment decisions. In recent Congressional testimony, Alicia Munnell, director of the Center for Retirement Research at Boston College, said, "Workers continue to have almost complete discretion over whether to participate, how much to contribute, how to invest, and how and when to withdraw the funds. Evidence indicates that people make mistakes at every step along the way. They don’t join the plan, they don’t contribute enough; they don’t diversify their holdings; they over-invest in company stock; they take out money when they switch jobs; and they don’t annuitize at retirement."
More flexible target date funds. Even with the hits taken by target-date funds, they remain an attractive vehicle for retirement programs. However, expect the industry to respond to recent poundings by making the age of the account holder only one of several key variables in a fund's objectives. Wealth, other income sources and personal and family objectives will increasingly be considered. Hartford Financial Services just expanded its family of target date funds. Expect similar moves from other providers.
Higher fees, less service, or both. Big mutual fund families have suffered sizable revenue cutbacks. The industry has lost at least a couple of trillion dollars in account values, which translates into substantial lost fee income. Vanguard, known as one of the lowest-fee fund providers, recently moved to raise its fees and other funds likely are considering similar moves.
More self-directed funds. Poor returns plus higher fees equal an investor retreat into self-managed accounts. These accounts can, of course, invest in mutual funds, but the retirement-plan fees that major fund families have enjoyed will be under assault. Mass-market investors already had been moving to self-service accounts because personalized advice was not available to them, notes a recent report from Celent, a financial consultancy. Now, it says, that trend will be accelerated and joined by 401(k) account holders rolling into self-directed IRAs. At the same time, the big do-it-yourself houses such as Schwab, TD Ameritrade, E-Trade and others will be expected to build better customer communication programs. Otherwise, the poor decisions made by investors in managed retirement programs will simply be repeated.
Going, going, gone? Financial pressures, market declines, and the push for simpler and more transparent funds all argue for a world of fewer funds. That trend hasn't yet been seen. According to the Investment Company Institute, the number of funds is largely unchanged during the past year. However, the Celent report, which dealt with implications of the financial crisis for the wealth-management industry, says stock mutual funds are quite simply the biggest loser in the market's upheaval:
"It is highly likely that mutual funds as an asset class are in a permanent decline unless regulations change. ETFs are more cost-effective and can be sold short. Active funds do not outperform the indices. Hedge fund take advantage of the long-only nature of mutual funds to arbitrage gains away from the mutual funds into the hedge funds. Lifecycle funds do not achieve their touted objectives of becoming stable as retirement arrives. Celent projects that within five years, unless the regulations are changed to put mutual funds on a more equal footing, fund families will decline from over 7,000 to closer to 2,000."