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Exclusive Interview: Ron Surz Says Regulators Can’t Solve Target Date Fund Problems

June 17
00:02 2014

Ronald J. Surz is president & owner of Target Date Solutions, designer of the patented Safe Landing Glide Path®, which is the basis for the Brightscope On-Target indexes and the SMART collective investment trusts on Hand Benefit & Ron_SurzTrust, Houston. Ron has served on several boards and councils including the Investment Management Consultant’s Association (IMCA) Board of Directors and the CFA Institute’s Consultant/Investor GIPs Committee. He earned an MBA in Finance at the University of Chicago and an MS in Applied Mathematics at the University of Illinois, and holds a CIMA (Certified Investment Management Analyst) designation. Ron publishes regularly in industry publications and maintains The Fiduciary Corner on his Target Date Solutions Website, an extensive library of articles, videos and valuable resources for fiduciaries and advisors.

We first spoke to Ron nearly five years ago when we ran a series on Target Date Funds. We’ve always been impressed with his forthrightness, his ability to provide real-life illustrations and his eye for identifying critical data points for 401k plan sponsors. If this sounds a lot like the tag-line (“providing essential information, blunt commentary and practical examples of ERISA/401k fiduciaries individual trustees and professional fiduciaries”), then you’ll understand our desire to interview him upon the release of his new book Fiduciary Handbook for Understanding and Selecting Target Date Funds, (co-written with John Lohr and Mark Mensack).

FN: Ron, tell us a little about yourself and what got you interested in specializing in Target Date Funds (TDFs).
Surz: I’m a former rocket scientist who got interested in finance and the development of scientific decision making. Having earned an MS in Applied Mathematics I went to work for Northrop to develop electronic countermeasures to jam heat seeking missiles, but switched careers two years later to work for the largest pension consulting firm in the country at that time, A. G. Becker. At Becker I went on to earn an MBA in Finance from the University of Chicago and to rise to Senior VP of investment policy/asset allocation, a pretty techy role. I consulted to $trillions on their most important investment decisions. In 1986 I co-founded a new consulting firm called Becker Burke, and in 1992 I went out on my own to freelance, to find projects and ideas that flip my switch. In 2007 I found target date funds, and have been committed to creating the best design I can. My “Safe Landing Glide Path” was patented in 2013.

FN: A lot of bad things happened in the 2008/2009 collapse of the financial markets and TDFs have since become a poster-child for all that went wrong for retirement investors during that time. Can you briefly describe the key points we can take away from that awful experience?
Surz: 2010 TDFs lost 25-35% in 2008. It was shocking. The 2010 fund was for those retiring between 2005 and 2015. Imagine having a fourth of your savings wiped out at a time when you may not be able to stay in the workforce. This debacle should have been a wake-up call that TDFs were too risky at the target date. Investors in TDFs are financially unsophisticated because most assets are there by default, from employees who can’t make a decision. These beneficiaries thought their assets were safe, that their employers were protecting them.  Prior to the Pension Protection Act of 2006, the common default was very safe cash. The PPA authorized, and actually encouraged, more risk taking by excluding cash from the list of QDIAs. Unfortunately the risk pendulum has swung too far for those nearing retirement.

FN: Following this TDF debacle, Congress convened several hearings in 2009. There was a lot of talk about the seriousness of the problem with TDFs and even some recommended actions. What were some of most significant issues brought up in these hearings and the resultant recommendations made by Congress?
Surz: The hearings in June, 2009 were the only joint hearings ever. It’s very enlightening to watch the video. The SEC/DOL focus was exclusively on the 2010 funds, wanting to understand what went wrong. The fund companies said nothing was wrong, that participants should have understood the risks. Attorneys clarified that statement by saying plan sponsors choose TDFs, and it is they who should have understood the risks – they are the fiduciaries. In other words, attorneys laid the blame on fiduciaries who choose TDFs, but they’re not listening, even today.

The SEC/DOL reaction was a threat of more disclosure, including the inclusion of the ending equity allocation in the name of the fund. Fast forward five years to 2014, and nothing has happened yet, but the DOL is seeking comment again. Stay tuned. The DOL issued some “tips” last year, but tips are by definition mere suggestions.

FN: What has been done regarding these recommendations as a result of these hearings?
Surz: Very little good has happened since 2008. Unfortunately TDFs have actually become riskier at the target date. Fidelity recently increased their equity exposure, positioning for the performance horse race. Also, non-equities at the target date are mostly long-term bonds, which are hardly safe in a zero interest rate environment. It’s a disaster waiting to happen, this time 5 times as devastating as 2008 because TDF assets have quintupled in the past 5 years.

FN: Hmm, sounds like typical Washington – all talk and no action. Sometimes gridlock can be good. Sometimes it can be bad. Why are the fiduciary risks regarding TDFs so much greater today than they were in 2009?
Surz: TDF assets have grown from $200 billion in 2009 to $1 trillion today, representing about 25% of all 401k assets. So I say TDF fiduciary risks have quintupled. As is customary in most products, and especially investments, fund companies are calling the shots. Investments are sold, not bought. This is a shame on many fronts, especially fiduciary breach of the duty of care, which requires sponsors to buy the best and safeguard against foreseeable harm. The duty of care is like the duty to protect your children. It’s more than legal requirement; it’s an ethical obligation. In a democracy, government can’t dictate investment product, so nothing will change unless fiduciaries do their jobs, which will probably take lawsuits; that’s the American way.

FN: One of the problems of 2008 was that many TDFs weren’t around long enough to accumulate a track record, so no one saw their downside risk. That isn’t the case now. In general, what does the track record of TDFs as a whole look like? Are they performing as expected?
Surz: Track records really don’t matter much because most of the assets are going to the Big 3 bundled service providers – T. Rowe, Fidelity and Vanguard. That hasn’t changed much, except Vanguard is taking the lead primarily because of their lower fees. Current lawsuits are focused on fees. As I said, lawsuits dictate fiduciary behavior, and the evolution of TDFs. Regulators focus on public outcry.

FN: In your book, you describe what you call the “main objective” of TDFs and the fact that there is not universal agreement with this main objective. What is the “main objective” you describe and why has the financial services industry failed to reach a consensus as to whether it really is the main objective of TDFs?
Surz: The objectives that are being sold are actually “hopes”, which are objectives without a sensible plan. These standard objectives are to replace pay & manage longevity risk, tasks that can’t be achieved by asset allocation; saving enough is the right course of action for these “objectives.” But a one-size-fits-all can be designed to achieve a universal objective of not losing participant money. Can you think of anyone who would disagree with this objective? Financial engineering can offer a fairly high probability of achieving this Hippocratic Oath of TDFs. My 2010 fund was down 4% in 2008.

The industry hasn’t embraced this universal objective because it is less profitable – you can’t charge much for running safe assets. Any excuse for more risk will bring in higher fees because high risk investments command higher fees. The proof of the pudding is in the tasting. Open any TDF prospectus and look for the statement of objectives. What you’ll find are meaningless statements like “earn a return commensurate with the risks.” What you won’t find is any mention of replacing pay or managing longevity risk. Fund companies are smart enough to know that they can’t commit these objectives to writing, or it will bite them in the …

FN: One of the biggest misconceptions of TDFs – and one that is bound to confuse most plan sponsors – is the financial industry’s haphazard and often contrary definitions of “to” and “through.” How have these definitions become muddled and give us a few specific examples of what you mean?
Surz: “To” and “through” were coined at the 2009 hearings. Some fund companies explained their high risk at the target date by saying that they were target death funds, where the date in the target date was merely a speed bump in the highway of life. By contrast, “to” funds were declared to end at the target date. But the definition of “to” is based on allocation beyond the target date. What does “beyond” have to do with “end”? The definition of “to” is a flat equity allocation beyond the target date. Recognize that a constant 100% in equities is a “to” fund under this weird definition. Investors & regulators have come to believe that “to” is safer than “through” at the target date, but that’s just plain wrong. Many “to” funds are riskier at the target date than many “through” funds. It’s a distinction without a difference.

FN: Your book references specific liability risks (and even cites some cases) 401k plan sponsors assume as a result of placing TDFs on their plan menus. Can you generally describe these liability risks and perhaps give an example or two of a worst case scenario?
Surz: Most fiduciaries who use target date funds are violating their Duty of Care because they are not vetting their selection, choosing the Big 3 out of convenience & familiarity. They are relying on two safe harbors: (1) any QDIA will do; and, (2) you can’t go wrong following the heard (safety in numbers). These will not stand up in court. The Pension Protection Act of 2006 does not authorize fiduciaries to throw darts at the QDIA dartboard. “Safety in numbers” is a misery loves company view.

The catalyst for class action lawsuits will be the next 2008, and the basis will be avoidable losses. There will be a public outcry bemoaning the poor unsophisticated TDF beneficiaries. The question that will be repeatedly asked in court is “What did you do to protect against a re-occurrence of the 2008 debacle?” The duty of care requires protection against foreseeable harm. The worst case scenario is that sponsors and their advisers would be held liable for losses, and would have to compensate beneficiaries, and their attorneys of course. Just one major win would open the floodgates for mass class action lawsuits.  The only good news out of this upheaval is that TDF risk controls would improve.

FN: Some advisers believe the TDF concept is merely broken and could work if fixed properly. What are some specific steps you would recommend to the industry and regulators to fix the current TDF problem?
Surz: Advisers should be very scared of being implicated in the lawsuits that will happen. They are the only people who can fix TDFs. Regulators can’t and plan sponsors won’t. Plan sponsors rely on their advisers. Advisers can improve TDFs by establishing sensible objectives and by buying TDFs to meet those objectives. The most sensible objective I can think of is  protection – don’t lose participant savings.

FN: Some advisers – as well as plan sponsors more conscious of their personal fiduciary liability – believe the TDF concept is broken beyond repair. They fear TDFs mislead most investors by focusing on a particular retirement date and not on the general type of investment return needed by the investor to build up sufficient assets to retirement comfortable. As a result, these fiduciaries have spurned TDFs and turned to more traditional “one-portfolio” options like lifestyle funds and balanced funds.  Now dubbed “Target Risk Funds,” how do these funds avoid the “Date” problems of TDFs and how do they offer a philosophically different approach to long-term retirement investing than TDFs?
Surz: The best QDIA is a managed account, tailored to the specifics of the individual investor, and the best managed account is face-to-face individual consulting, but this is expensive. Managed accounts for the masses are available through firms like Financial Engines and Guided Choice but the actual experience indicates that many investors don’t use this advice at all or use it improperly.

Advisers are expressing more interest in the third QDIA, namely balanced funds, especially target risk. Target risk funds haven’t been criticized much yet because they’re not that popular, and there are reasons for the lack of popularity. If the plan sponsor chooses one target risk fund for all of the defaulted employees, the one-size-fits-all criticism has real teeth. How can one level of risk be appropriate for both a 20 year old and a 65 year old? Or the plan sponsor could group employees into risk groups, and use a family of target risk funds, which would make more sense. But then the sponsor needs some rules for mapping participants into risk groups, and an age-based rule also makes sense. Bottom line, the sponsor would take on the role of moving defaulted participants into lower risk funds over time, which is what a target date fund is designed to do. A target date fund is a sequence of target risk funds on auto pilot.

TDFs do have real benefits, namely diversification and risk control, preferably at a low cost. All three benefits can be substantially improved, but they won’t be unless there is demand from advisers. There’s been a little movement away from the Big 3, but it has been toward custom TDFs that suffer from the same problems as the non-custom. Also, “custom” uses the same cookie cutter provided by the consulting firm hired to construct a glide path.

FN: Is there anything you’d like to leave our readers to ponder upon?
Surz: The TDF train is speeding down a rickety track, projected to quadruple to $4 trillion in just a few years, representing half of all 401k assets. We – your readers and I – need to fix the track before it is too late, or get off the train.

Advisers have tremendous opportunities in TDFs, many of them reinforced by last year’s “DOL tips.” But these opportunities come with risks that advisers should not take lightly. The high-risk gamble the Big 3 are making at the target date will pay off, until it doesn’t.

FN: Ron, on behalf of and our many readers, thank you so very much for taking the time out of your busy schedule to answer these important questions on target date funds. We’re confident this information is pertinent to our readers. By the way, if any readers are interested in Ron’s new book, Fiduciary Handbook for Understanding and Selecting Target Date Funds, just go this this link (it’s available in both ebook and paperback). 

About Author

Christopher Carosa, CTFA

Christopher Carosa, CTFA


  1. Charles Humphrey
    Charles Humphrey June 18, 12:04

    Having read Ron’s book, I’m a big fan. The book should be required reading for every 401(k) plan fiduciary. Thanks for bringing Ron’s very knowledgeable perspective to your readers on a topic that grows more important every day.

  2. Joel L. Frank
    Joel L. Frank June 18, 14:25

    It stands to reason (or does it?) that when TD investing is used by employees to supplement their DB pension accruals their allocation to equities should AT ALL TIMES be greater than if the supplemental plan was the employer’s primary retirement plan.

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