Non-traditional investment allocations in defined contribution plans, while commonplace in defined benefit pension portfolios, are a rare sight in today's retirement plan lineup. Despite an obfuscated financial marketplace, many experts are saying now is the time for DC plan sponsors to consider more exposure to alternative investments.
Recent commentaries from the Defined Contribution Institutional Investment Association andBNY Mellon Retirement Group mandate that varied commitments and percentages in these investment strategies could warrant DB-like returns if adopted.
In May, the Washington-based nonprofit association charged with improving American worker retirement security said DC plans are missing out on diversification dividends due to an overly heavy equity proportion. From 1997-2011, the DCIIA said that DC plans' 5.8% return lagged behind DB returns by 1.4% points.
While traditional investments, which include fixed-income and equity capitalizations, dominated DC portfolio allocations, zero percent was promised to alternatives over this 15-year span, the DCIIA said in its paper titled: Is It Time to Diversify DC Risk with Alternative Investments?
"It's historically been a significant performance gap between more institutional areas and DC plans, and some of that gap has been the failure to use alternative investing and other strategies in DC," said DCIIA Executive Director Lew Minsky.
In April, the Securities and Exchange Commission Investor Advisory Committee adopted a recommendation to improve target-date fund marketing and advertising practices that will show that information and fund risk is easily communicated. Target date funds totaled about $485 billion in 2012.
Because about 70% of employers offer "target date funds as their default investment option" in DC plans, the federal regulator listed that more lessons are needed because evidence shows that individual investors are "ill-equipped" to identify those risk disparities.
The DCIIA paper recommends absolute return, total return, private equity and real estate as ingredients to a possible recipe for return success.
For adoption purposes, the organization suggests that target-date funds or other multi-asset classes could give plan fiduciaries greater control over how they make alternatives available to plan participants.
"It seems it would be beneficial for participants in defined contribution plans to have access to investment options that provide multi-strategies, or encompassed alternatives in areas like private equity that could enhance the return profile of their investment portfolio," HarbourVest Partners' Managing Director Gregory Stento said.
Chicago-based Northern Trust commends this transition. Its Defined Contribution Solutions Group is a believer "in alternative or 'nontraditional' asset classes, like global real estate, commodities and emerging markets," according to Senior Product Manager Suzan Czochara.
"We believe it makes sense to add [these] asset classes that may help hedge participant portfolios, when-not if-inflation begins to rise," Czochara explained, noting that "in most cases it does not make sense to do so on a stand-alone basis as a core fund option."
Industry on-lookers are projecting that the vehicle can allow for additional allocation splits to include alternative vehicles that would sacrifice the daily value disparity, currently promised to mutual fund and retail investors, in favor of a more diversified portfolio.
"...It would be nice to have an investment vehicle where it doesn't have to be liquid at all times, and so the one thought is these default strategies; while the entire strategy needs to be traded daily, it doesn't mean that every sleeve and every subcomponent needs to be 100% liquid at all times," Minsky said.
But, the DCIIA executive director noted that there is "both a push and pull going on," highlighting that a move toward more adoptions in alternatives is being faced head on by other forces.
Fully in agreement, BNY Mellon Retirement Group Executive Vice President Robert Capone said that key for DC investment plans is a shift away from "traditional style box categories" where more than 70% are invested in equities.
"We have far more equity risk and home country biases in DC plans because there is a heavier allocation to equities than you have in the DB plans," Capone said.
In his June 6 white paper: Retirement Reset: Using Non-Traditional Investment Solutions in DC Plans, Capone projects that a simple 20% bump up in real assets, emerging markets securities and liquid alternatives could speak volumes for returns.
"I think the biggest thing is, you are looking at an industry [the DC plans] that is very slow to change, Capone said. "Historically, defined contribution as an industry doesn't typically embrace new things."
New England Pension Consultants, a Cambridge, Mass.-based advisor, agrees. The DB and DC consultant advises over $700 billion in assets for its more than 300 retainer clients in both traditional and alternative vehicles.
"The challenge is communicating to participants, understanding the benefits of it, and what the exposure should be as well," Rob Fishman, a partner in the DC Group at NEPC, said.
Since 1987, NEPC has provided consulting services to DC investment portfolios. Fishman disclosed that a lot of the focus is on the downside protection and daily liquidity but added that the consultant's clients in the space have already included forms of the above listed strategies.
One problem is "a lot of plan sponsors don't want to be the leaders and stand out relative to their peers," Fishman confessed. Another challenge is finding something that complements the current retirement investing machine.
"In order for this to work," Capone noted that "we really have to get to all the dimensions of influence, the sponsors, the consultants, the record-keepers, they all have to embrace the fact that these asset categories could work."
But, "like everything in DC, the timing is right, but I do think we're talking about time...a multi-year effort [and] a multi-year campaign," Capone said.