Target date funds get their comeuppance

A lawsuit is poking holes in an investment product increasingly seen as cure-all for clients looking to bypass investment advisors

State Farm Investment Management in the U.S. is being sued by two investors who allege that the firm violated its fiduciary duty by charging excessive fees for its LifePath target date funds.

The interesting wrinkle in this case is the argument the investors make for why State Farm has breached its fiduciary duty.

“The amount of the management fee extracted and retained from the LifePath Funds by State Farm is so disproportionately large that it bears no reasonable relationship to the services rendered (if any) in exchange for that fee,” the complaint states. “It is difficult to determine what management services, if any, State Farm provides to the LifePath Funds, since virtually all the investment management functions of the LifePath Funds are delegated to BlackRock.”

The investors claim that State Farm received approximately $17.5 million in management fees for providing almost no service to the target date funds while BlackRock, the sub-advisor, received a similar amount of compensation but provided virtually all of the investment management advice.

You can see where this is going.

State Farm, the complainants believe, should have passed along the savings it garnered from the economies of scale available to its five LifePath target date funds whose assets under management totaled $6.25 billion at the end of 2014.

“The work required to operate a mutual fund does not increase proportionately with the assets under management,” the complaint alleged. “These benefits can (at least in part) be shared with the LifePath Funds, plaintiffs and other shareholders in these funds by reducing fees and other costs charged to the funds.”

If the target date funds charge a net management fee of 62 basis points with half going to State Farm and half to BlackRock, they believe that some portion of the 31 basis points going to State Farm should be reimbursed to investors.

With CRM2 to be fully implemented by July 2016 you can bet the same sort of argument will make its way to Canada.