By Tom Bradley

Be warned. I write this after a long day, a glass of wine and having just read an article on ‘Target Date’ funds in Monday’s Report on Business. Shirley Won’s piece on these packaged, marketing-driven, fee-laden, deceptively complex, misrepresented products has got me stirred up.

First some background. These funds are part of a group of products called ‘life cycle’ funds. The original idea was to design and manage each fund for a particular demographic (i.e. investors retiring in the year 2010, 2020 or 2030). The manager would adjust the asset mix as the retirement date approached. For instance, a 2030 fund would be invested mostly in equities right now, but would be more conservatively managed 10-12 years from now. As it nears its 2030 target date, it would largely be invested in stable income-oriented securities.

When offered as a simple mutual fund, there is nothing wrong with these products, although there are cheaper, more flexible ways for investors to accomplish the same goal. They went off the rails when marketing and investment banking departments tried to enhance sales appeal and profitability by adding features, such as guaranteeing the highest net asset value.

Every fancy add-on sounds appealing and makes the product easier to sell, but it eats into the long-term return, increases the number of possible unanticipated outcomes (see below) and puts the manager in a conflict of interest. With a guarantee for instance, the fund’s first priority is to make sure the bank doesn’t lose any money. The client’s interests come second.

Consider one of Shirley’s examples, ‘Guaranteed’ funds with target dates that are more than ten years into the future. Many of these funds are now invested 100% in bonds because the asset mix was shifted to ‘guarantee’ the banks’ profitability. When a rational investor should be taking advantage of lower prices, depressed valuations and a less risky market, these managers were forced to sell their stocks and buy bonds.

As investors, we all have the misfortune of sometimes buying high and selling low, but to do it intentionally and without fail just doesn’t make sense.

The target date funds are not the only products that encourage the manager to act against the clients’ best interests. Over the last five years, we have seen a whole generation of products develop that force a similar behavior. Some products use leverage in a counter-intuitive way – i.e. increasing it when markets are going up and decreasing it when they fall. Again, it sounds good, but what it means is that investors go up with less leverage than they go down with.

The wealth management industry’s marketing imperative and urgency to get new products out the door is leading to the sale of billions of dollars worth of flawed, misleading and sometimes abusive products. Perhaps it should do what the software industry does – ask the product designers, marketers and executives of the bank to 'beta test' these products before they’re made available for broad distribution. Let them work out the bugs and live with the fees, illiquidity and unexpected consequences for a few years.

In the meantime, it’s time for that second glass of wine and an episode of The Family Guy. That will settle me down.