Adoption of alternative investments as DC menu options has
been modest so far, according to the 2013 PLANSPONSOR Defined Contribution
Survey. Last year, 28.2% of plans offered a real estate/real estate investment
trust (REIT) fund, up from 12.1% in 2009, while 5.5% provided such alternative
options as hedge funds or private equity, up from 2.3% in 2009.
Current Usage
Trends
For sponsors that want to offer a real estate option on the
core menu, a REIT fund makes sense because of its liquidity, high streams of
dividend income and more conservative performance compared with other
alternative investments.
Investors also like the Internal Revenue Service (IRS)
requirement that REITs pay 90% of their profits as dividends, he says. And both
sponsors and participants often feel more familiar with real estate than they
do with other alternative investments.
Plans have also been adding Treasury
inflation-protected securities (TIPS) funds to their lineups in recent years,
says Ross Bremen, a partner at investment consultant NEPC LLC in Boston. About
one-quarter of 401(k) plans now provide them as an option.
Other alternatives strategies such as private equity or
hedge funds have complex investment strategies and characteristics that can
present liquidity, transparency and other challenges to defined contribution
plans. The fees for alternative investments also can dissuade sponsors. Still, the unlikelihood of participants making
big bets on alternatives has, so far, limited their use as core menu options.
The first significant wave of target-date funds investing in
alternatives came after the 2008/2009 market crisis. Many target-date funds
suffered from their heavy allocations to traditional asset classes, including
equity allocations, but fixed-income holdings also contributed to unexpectedly
large losses for some funds.
Future Growth
Potential
Some large-plan sponsors with both defined contribution and
defined benefit plans have begun utilizing their DB alternative investments
within custom target-date funds in their DC plans. Using the investments in
master trust arrangements, these target-date funds get exposure to
alternatives, such as private equity, that they otherwise would lack.
The long-term investments can have a so-called “illiquidity
premium” that enhances returns, and a better-diversified portfolio also lowers
downside risk for participants. These sponsors see the target-date fund
approach as a way to more safely give participants exposure to a broader array
of alternative investments, without the risks of offering those exposures as
core menu options.
Despite the current trend toward simplifying investment
menus for participants, there is potential for growth in alternatives as a core
defined contribution menu option. But for alternative strategy mutual funds to
have more potential as a core menu option, participants need to be educated
about how to utilize them effectively and what to expect.
‘Liquid Alt’ Mutuals Gain Momentum
Retail investors are beginning to invest in alternative
strategy mutual funds. Their motive: to avoid a repeat of the decline in their
portfolios that many experienced in the 2008/2009 equities downturn.
The quantity of alternative strategy mutual funds—also
called “liquid alt” mutual funds—has risen steadily from 215 in 2008 to 442
this year, according to Morningstar. Total net assets in the funds has jumped
from $49.6 billion at year-end 2009 to $139.4 billion in 2013.
But alternative strategy funds also can differ from typical
equity and fixed-income funds, he says. For example, an alternative strategy
fund may use leverage by borrowing money from a bank that the fund then
invests, in hopes of generating higher returns.
The study also notes that, among alternatives strategies,
the nontraditional bond category had the most wirehouse-based assets last year.
Click
here to access the full article on PLANADVISER.com