Target date funds: Don’t let your guard down

A 2017 survey conducted by FSCO found target date funds to be the most common default member-directed investment option offered by Ontario-registered defined contribution (DC) pension plans. Target date funds adjust and purport to reduce risk of the fund’s asset allocation according to the age or expected retirement date of an individual plan member, accounting for the circumstances and risk tolerance of the investor class as a whole.

However, it is important to remember that where target date funds are part of your investment platform, they must be selected and monitored in accordance with applicable law, in the same way as other investment options. This article will briefly canvass the regulation of and potential risks associated with target date funds.

Regulation of target date funds in Canada

Target date funds have been increasingly included among the investment choices for member- directed DC pension plans, and have received some support by governments and regulators.  For example, pension standards regulations in both Alberta and British Columbia require that the default investment option for DC plans offering member-directed investment choice be either a balanced fund or a “portfolio of investments that takes into account a member’s age.”^[1] The federal Pension Benefits Standards Act, 1985 requires administrators of DC plans and defined benefit plans with additional voluntary contribution options to offer investment options – including default investment options -- with varying degrees of risk and rates of return that would allow a reasonable and prudent person to “create a portfolio of investments that is well adapted to their retirement needs.” Where this standard is satisfied, the administrator will be viewed as fulfilling the statutory duty of prudence in respect of investment of plan assets.^[2]

Target date fund related litigation

In Canada, we are not aware of any class action litigation related specifically to target date funds.   However, in the U.S., there has been class action litigation launched for breach of fiduciary duty related to target date funds.  In the U.S. actions, the allegations include:

• failure to implement a process to control investment management expenses in the selection and monitoring of the plan’s investment options, including the target date funds;
• imprudently designing the plan’s custom target date funds and utilizing inappropriate and speculative investments in the process of implementing the funds; and
• failing to promptly remove target date funds once the investment became imprudent.^[3]

Plaintiff litigation counsel in the U.S. is also looking into various issues related to the selecting of target date funds, including where the employer improperly selects its proprietary target date funds.

Do your diligence: upholding the prudent person standard

In order to mitigate risk involved with selecting a particular target date fund and, where applicable, designating such fund as the default investment option, administrators should document the process and rationale for (i) selecting the chosen target date fund over other target date funds or other investment options, and (ii) reviewing the design, performance and suitability of the target date fund on an ongoing basis.  Administrators should regularly review the target date funds and the underlying investment funds, noting their performance against appropriate benchmarks and monitoring the fee structure. It is also important to monitor changes in plan demographics which may impact what is “appropriate”.

In conclusion, an administrator must adhere to its common law fiduciary duties and the standard of care set out in pension standards legislation in the selection of target date funds as an investment option in member-directed DC plans and the ongoing monitoring of such investment option. The design of target date funds, with risk adjustment as participants age, may make them more attractive to administrators as default options in member-directed DC plans.  However, this does not mean that there is a different standard of care applicable to administrators in selecting and monitoring these funds.