Target-date funds got a huge boost from the Department of Labor’s final regulation on qualified default options for defined-contribution plans with automatic enrollment. But industry observers say the investment structure of the funds is deeply flawed by their high exposure to stocks.

The new DOL regulation says qualified default investment alternatives will be target-date funds, managed accounts and balanced funds. By choosing one of these options as a default, plan sponsors can avoid a certain amount of fiduciary liability.

Target-date funds are viewed as the big winner. Allocations to the funds will grow to 56 percent of assets in all defined-contribution plans by 2011, up from 11 percent this year, estimates the TowerGroup, a Needham, Massachusetts-based research and consulting firm that focuses on the financial services industry. Assets in these funds, which decrease in equity holdings as a participant ages, now hold about $370 billion of retirement plan assets, up from $150 billion at the end of 2004, according to Financial Research Corp., based in Boston.

The DOL regulation, which goes into effect December 24, gives a nod to stable-value funds. The life insurance industry fought hard to have them included as a qualified default investment alternative, and the funds are considered the big loser under the change. The rule says plan sponsors could receive legal protection by placing employee investments in a stable-value fund for the first 120 days of their participation in a defined-contribution plan.

Bradford P. Campbell, assistant secretary of labor and head of the Employee Benefits Security Administration, says that the temporary default was offered as an administrative convenience for plan sponsors.

In addition, the DOL’s new rules provide protection for investments made in stable-value funds before the December 24 effective date of the new regulations. The grandfathered protection is intended to minimize costs associated with transferring the funds.

Although target-date funds win this battle, it’s unclear whether the funds will provide adequate retirement income for plan participants.

"Three years ago, if you looked at an average target-date fund, 50 percent of assets were in stocks until you [were] 60; now it’s much higher," says Richard Glass, president of investment advisory firm Investment Horizons in Pittsburgh. "The problem is comparing the different target-date funds. If I have 50 percent in stocks, and the next guy has 30 percent and the market is up, the 30 percent guy will look bad. At what point is the goal to conserve assets rather than go for growth?"

This story was filed by Jenna Gottlieb and Doug Halonen Pensions & Investments, a sister publication of Workforce Management. To comment please e-mail editors@workforce.com.