The Department of Labor and the SEC are holding a joint hearing today in Washington to explore “issues” related to target date/lifecycle funds. Many of these funds actually underperformed the S&P 500 last year. You can watch the hearing live until 5:30pm.
Target date funds have rapidly gained in popularity since they were introduced in 1996. In 2000, there were only 23 funds with $8 billion in assets, according to Lipper; today there are nearly 300 with $176 billion in assets.

The attraction is obvious. They offered a simple solution to the retirement conundrum of picking mutual funds for one’s 401(k)—pick one fund that does it all, offering diversification and shifting from equities to bonds as you grow older and ripening just in time for your retirement. In short, they were designed to take all the thinking away from the investor—a risk-conscious retirement vehicle on auto-pilot.

Then the market crashed.

Nearly every asset class was trampled. But for many target date funds, the losses have been more severe than they should have been since many of the funds didn’t keep the promise of shifting to bonds. A recently released analysis of 72 target-date funds by consulting firm, Watson Wyatt, showed quite a bit of variation between allocations in funds with similar dates: shorter-horizon funds contained anywhere between 32 and 80 percent in equities while longer horizon funds contained a slightly higher range of 51 percent to 95 percent in equities.

Not surprisingly, losses have been severe. “Target date funds have produced some troubling investment results,” said SEC Chairman Mary Schapiro in a June 2 speech before the subcommittee on Financial Services. “The average loss in 2008 among 31 funds with a 2010 retirement date was almost 25 percent. In addition, varying strategies among these funds produced widely varying results. Returns of 2010 target date funds ranged from minus 3.6 percent to minus 41 percent,” said Schapiro.

One vocal critic of today’s target date funds is Frank Sortino (for whom the risk measurement, the Sortino Ratio, is named). Sortino, a professor of finance at San Francisco State University, is the director of the Pension Research Institute in Menlo Park, where for several decades he’s been developing different ways to measure risk. He says the chief tenet of Modern Portfolio Theory—that every investor is seeking to maximize expected return for a given level of risk—is bogus. He may be among a minority who dismiss MPT. Sortino subscribes to “Post” Modern Portfolio Theory, and he certainly isn’t alone. Risk, he says, is better defined by the individual’s goals, or more accurately the risk of not meeting them. In this paper posted online, he explains: “These types of funds make asset allocations based on age and preferences rather than needs. This allocation methodology might well protect sponsors from liability based on Department of Labor guidelines, but how could anyone be so naive as to think, say, a top executive of a company and a janitor should have the same portfolio because they are the same age and claim to have the same risk tolerance?”

Sortino has suggestions for improving the pension/401(k) market which he summarizes in this article, posted in March in Pensions & Investments.