SEC calls out conflicts of interest in TDFs
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Many sponsors of the popular 401(k) funds don't disclose their use of underlying in-house investments.
The Securities and Exchange Commission took aim at conflicts of interest in target-date funds on Thursday, calling out a fund structure that holds the majority of 401(k) investors’ assets.
The agency’s Office of Compliance Inspections and Examinations issued an alert saying some TDFs provided “incomplete and potentially misleading disclosures” around conflicts of interest, such as those that could arise from “the use of affiliated funds and affiliated investment advisers.”
Such a fund structure — in which a TDF provider uses its in-house investment funds as the underlying building blocks for its TDFs — is common among the largest target-date providers.
At the end of last year, 95% of target-date assets were held in TDFs that used only proprietary funds, according to Sway Research, which studies asset management distribution in retirement plans. Of the top 10 largest TDF providers by assets, only one company — Principal Financial Group — uses a different model.
The result is that when 401(k) investors direct money to TDFs sponsored by companies such as Vanguard Group, Fidelity Investments and T. Rowe Price, they are directing money to those companies’ other mutual funds, such as large-cap stock or bond funds, as well.
TDFs have roughly $1.8 trillion in mutual funds and collective investment trust funds, according to Sway Research.
“It’s one of those sticking points with TDFs,” said Chris Brown, founder and principal of Sway Research. “A huge chunk of the assets are being directed back into their own products.”
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One issue this raises for investors, Mr. Brown said, is that it’s unlikely an asset manager is the best choice across all of the asset classes in a target-date fund.
It appears the SEC thinks some asset managers are inadequately disclosing this conflict to retirement investors. The agency’s notice took the form of a “risk alert” highlighting its findings from a recent sweep of more than 30 target-date funds, including both “to” and “through” funds.
Most asset managers have used this TDF structure since the funds’ inception more than a decade ago. But the funds have quickly grown to be the most popular investment option for 401(k) participants. The funds currently capture around 58% of 401(k) contributions; that’s set to increase to more than 80% in 2023, according to consulting firm Cerulli Associates.
The SEC also said TDF providers offer incomplete or misleading disclosures around asset allocations (both current and prospective over time), relative to glide-path changes and the impact of these changes on asset allocation.
Many TDFs, according to the SEC, also had “incomplete or missing procedures” around monitoring asset allocations; overseeing the implementation of changes to glide-path asset allocations; overseeing advertisements, which may have been inconsistent with fund prospectuses; and monitoring whether disclosures around glide-path deviations were accurate.
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