WHITE PAPER. The TDF Transparency Code Voluntary disclosure best practice for Target Date Fund managers

Transcription

1 WHITE PAPER The TDF Transparency Code Voluntary disclosure best practice for Target Date Fund managers

2 Introduction Target Date Funds (TDFs) are a welcome innovation that offer professionally managed strategies to investors who may not have the willingness or ability to manage their own investment decisions and may be reluctant to engage, whether directly or through an adviser. For this reason TDFs became the most popular form of default fund in the US after auto-enrolment commenced there in In the UK, NEST has selected a TDF approach to deliver its investment solution for automaticallyenrolled customers, setting a benchmark in terms of industry best practice, which is fully compliant with DWP s guidance on default fund design 1. The US Example The US Department of Labor s (DoL) Employee Benefits Security Administration (EBSA) is commendatory in regard to TDFs as Qualifying Default Investment Alternatives (QDIA), while flagging the risks inherent from heterogeneity: TDFs are designed to make it more convenient for individuals saving for retirement they allocate investments among different asset classes, and change that allocation to become more conservative over time. However, TDFs are not managed according to uniform strategies. TDFs with the same target date can have very different investment strategies and asset allocations. Participants and investors may not understand these differences, which can lead to different levels of risk and investment results over time. 2 TDFs strategic and tactical asset allocations over time, or glidepaths, are necessarily heterogeneous given different managers investment policy, outlook and process. As long as the different strategies are clearly articulated by the manager, and properly understood by the investor, heterogeneity per se is not a problem. However, as the sector expanded rapidly in the US from , consumers in the US were unaware of the heterogeneity of different managers glidepaths. The differences only came to light during the global financial crisis, when TDFs of identical target date showed a large dispersion of returns, even for funds that were approaching their stated target date. For example, the Oppenheimer Transition 2010 fund had 60% equity allocation in 2008, just two years from maturity, which suggests that the managers were chasing returns, rather than following a disciplined glidepath 3. Research suggests that in the period , prior to and during the global financial crisis, TDF performance was sub-optimal, with a surprisingly high (and increasing) exposure to equities in the run up to the crisis. 1 For UK guidance on default fund design criteria, see 2 US Department of Labor, EBSA, Target Date Retirement Fund Disclosures Factsheet, 29 th November Laurence Booth & Bin Chang, Target-date Funds: Good News Bad News, University of Toronto, December

3 The consumer outcry that followed created considerable controversy around TDFs, despite their ongoing popularity as a default alternative. The US authorities responded with an extensive review of Target Date Funds at a Department of Labor and SEC Joint Public hearing 4. Most of the panellists concurred that target-date funds were a welcome innovation for investors but that greater disclosure was required 5. In response to the hearing s findings, the US Department of Labor s Employee Benefits Security Administration (EBSA) released a rule 6 in November 2010 that required TDF providers to disclose to potential investors: A narrative explanation of how the TDF s asset allocation will change over time, and the point in time when it will reach its most conservative position A graphical illustration of how the TDF s asset allocation will change over time, and For a TDF that refers to a particular date (eg Retirement 2050 Fund ), an explanation of the relevance of the date In parallel, the US regulator, the Securities & Exchange Commission (SEC), set out its own rules on TDF disclosure and marketing material to ensure consumers were better informed and protected 7, while allowing Target Date Funds to continue to make it easier to invest for retirement by providing the simplicity for which many investors yearn 8. These SEC rules are the basis for our voluntary TDF Transparency Code for UK TDF managers. As auto-enrolment commences in the UK, it is essential that TDF managers provide clear and regular disclosure as to their current and expected strategy, enabling interested parties: employers, providers, advisers and consumers to make informed choices. 4 For full transcript, see 5 Ibbotson s Reaction to the Joint SEC DOL Target-Date Fund Hearing DateHearingCommentary.pdf 6 US Department of Labor, EBSA, Target Date Retirement Fund Disclosures Factsheet, 29 th November For SEC s recommendations, see summary and, in detail 8 SEC Press Release 3

4 Our Proposals for a TDF Transparency Code We are proposing that managers of Target Date Funds in the UK voluntarily comply with our TDF Transparency Code, while the sector is still in its infancy. With millions of customers about to be auto-enrolled into NEST and other TDF-based schemes, in what could be their first savings experience, it is essential that disclosure is full and transparent both to treat customers fairly and to enable them to make informed decisions. A kitemarking system could be developed so that consumers are aware that managers are compliant with this TDF Transparency Code. We would welcome feedback from consumer groups on what might be appropriate. Without the TDF Transparency Code, there is a risk that the US debacle is repeated in the UK as more managers launch TDFs with poor or inconsistent disclosure. This would damage Target Date Fund s status as the best practice default option, and may by association discredit auto-enrolment in general. Our code is divided into three sections: Section 1: A statement of principles; Section 2: A checklist for factsheets and similar material (eg prospectuses etc); and Section 3: A checklist for marketing and similar material (circulars, brochures etc). Compliance with the code We reviewed examples of some US and UK Target Date Fund factsheets to see to what extent they complied with the 5 points on the SECTION 1 Checklist of our TDF Transparency Code. Unsurprisingly, the US example was fully compliant. The UK examples were only partially compliant with our code, confirming that there is scope for standardising disclosure, and an urgent need for compliance with our TDF Transparency Code outlined above. TDF Manager Factsheets: Compliance with the Code Score US: Fidelity Advisory Freedom 2035 Fund Jun % UK: Fidelity Investment Funds IV Target 2030 Fund May-12 40% UK: NEST 2040 Retirement Fund (version A) Dec-11 40% UK: NEST 2040 Retirement Fund (version B) Dec-11 40% UK: AllianceBernstein Target Date Retirement Fund Mar-12 80% Source: Elston Consulting research, fund manager factsheets Next steps We look forward to working with TDF managers to formalise our proposed TDF Transparency Code. 4

5 The TDF Transparency Code SECTION 1: A Statement of Principles Descriptive material relating to Target Date Funds should disclose current and target asset allocations using standard asset-type definitions. Descriptive material should present a visual glidepath using standard asset-type definitions over the life of the fund from current date to target date and beyond the target date. Descriptive material should, in addition to the standard risk warnings, encourage ongoing monitoring and review of the suitability and affordability of the TDF. SECTION 2: Checklist for factsheets and similar material 1. Use simplified standardised asset-type definitions (Domestic Equity, International Equity, Alternative Assets, Bonds, Cash) 2. A table or diagram showing a summary of current asset allocation using simplified standardised definitions (with additional breakdown/categorisation as required) 3. A table or diagram showing summary of target asset allocation using simplified standardised definitions (with additional breakdown/categorisation as required) 4. Inclusion of a verbal description of target asset allocation at target date in the investment objective statement 5. A prominent table, chart or graph that clearly depicts the glidepath of the expected asset allocation (using standardised asset-type definitions) over the entire life of the fund before, at and after the Target Date. The table, chart or graph would be adjacent to a statement that the asset allocation changes over time, noting that the asset allocation eventually becomes final and stops changing, and noting the number of years at or after the target date at which the asset allocation becomes final and provides the final asset allocation. SECTION 3: Checklist for marketing and similar material 1. Linking name to current and target asset allocation Marketing material for a target date funds that includes the target date in its name should disclose alongside the fund s name the first time the fund s name is used: a) its current asset allocation (eg equities, bonds, alternatives and cash) b) asset allocation at target date and the number of years to target date 2. Risks and Considerations Target Date Fund marketing materials should include a statement informing the investor a) To consider their risk tolerance, personal circumstances and complete financial situation b) That an investment in the fund is not guaranteed and that it is possible to lose money by investing in the fund, including at and after the target date. c) That the intended percentage allocations of a target date fund among types of investments may be modified without notice, subject to any tolerances that may or may not be disclosed. 3. Mitigating mis-selling risks a) Marketing material should avoid placing emphasis on a single factor such as age or personal income as the basis for determining that an investment is appropriate. b) Marketing material should avoid making representations that investing in a TDF is a simple investment plan that requires little or no monitoring. 5 September 2012

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7 About Elston Consulting Elston Consulting is an investment consultant providing research and analytical support to investment intermediaries. Our focus is to research and develop packaged investment strategies, in particular Target Date Funds, to assist providers and intermediaries in the context anticipated industry changes resulting from auto-enrolment, and the Retail Distribution Review. For more information on Target Date Funds, please visit our dedicated website: Contact Post Web Elston Consulting Limited Bedford Row LONDON WC1R 4JS Tel Fax Notice This document is not an advertisement or financial promotion. It is provided for informational purposes only and is not intended to be an offer or solicitation, or the basis for any contract to purchase or sell any security or other instrument, or for Elston Consulting Limited to enter into or arrange any type of transaction as a consequence of any information contained herein. The views and opinions expressed in this article are those of the author and do not necessarily reflect the official policy or position of Mirabella Financial Services LLP. This document is issued by Elston Consulting Limited registered in England & Wales, registration number , registered office Bedford Row, London WC2R 4JS. Elston Consulting Limited is an Appointed Representative of Mirabella Financial Services LLP, which is authorised and regulated by the Financial Services Authority. Elston Consulting Limited 2012 All rights reserved No unauthorised reproduction Images reproduced under license

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