Alternative Reality

It’s hard to track the investment landscape in the U.S. recently and not see at least one report touting either the immediate or long-term potential of alternative investments, particularly private markets.

That is, except in one stubborn area for alt proponents: workplace retirement plans, where alts, in the words of Cerulli Associates in a study issued Wednesday, “are not yet compatible with defined contribution plan sponsors incentives and regulatory requirements, due to their relative illiquidity and opaque nature.”

In a survey of DC investment-only asset managers conducted by Cerulli, more than half have no plans to add or have not thought about adding two of the largest private market fund types to defined contribution investment only offerings. A bit part of that hesitancy is the regulated nature of the DC space, with a plan fiduciary unlikely to “casually” recommend a private equity investment that carries a 2% fee and operating expenses over “the average target-date fund” at about 65 basis points.

Meanwhile, alternative asset managers seem to be getting the message: Of that group, when given a list of the top institutional prospects for alternatives over the next 24 months, DC plans placed last, with only 15% expressing interest in the market.

The firm pointed out that real estate, considered an alternative investment in DC plans, may become a more viable option as an illiquid, long-term investment play.

Cerulli didn’t rule out the possibility of private market, private equity or hedge fund investments making it into plans some day, with the most possibility in multi-asset-class investment products that could be included in a plan menu. When asset managers were asked if their firm plans to add private equity or private real estate into a multi-asset-class product, including TDFs, the answers showed at least some signs of inclusion.

Alternative Motive

Overall, 46% were not planning to add private equity in the next 12 months and 41% were not planning to add real estate. But, when asked if they would consider adding private if asked by a plan adviser or sponsor, 23% said yes to private equity and 15% said yes to real estate.

When it came to offering the options within such products, 8% said they were offering private equity, 4% said they would be offering it in the next 12 months, and 19% said they were offering real estate. Meanwhile, another 15% said they were in the initial fact-finding stages for private equity and 22% for real estate.

The consultancy expects continued consideration and innovation for private market managers to enter the DC space, noting its multi-trillions in assets and precedent for inclusion of private equity in corporate pension funds. It also noteed the DC sector may be frustrated by not being able to provide participants with access to private markets that institutional investors are enjoying.

“The argument could be made that participants are pigeonholed in these [DC] plans, forced to choose among a handful of options largely unknown or unappealing to the normal investor,” Cerulli researchers wrote. “On the other hand, plan sponsors often feel trapped, afraid of including funds that could be interpreted as overpriced and underperforming, with litigation being a frequent outcome.”

In the meantime, the alternative asset managers believe he best opportunities for alternatives are in the ultra-high-net-worth and single-family office space (65%), sovereign wealth funds (65A%), public pension plans (65%), endowments, foundations and corporate pension plans (55%) among other areas.

Mutual Fund Outflows

Cerulli’s report included monthly flows for mutual funds and exchange-traded funds, along with consideration of target-date funds with embedded annuities. The consultancy noted that mutual funds, common in DC investing, saw “rare inflows” in February, but returned to outflows of $11.2 billion in March, as led by actively managed funds at $24.6 billion in outflows.

Taxable bond and municipal bond mutual funds saw gains, while U.S. equities, alternatives and commodities and other mutual fund areas had outflows, according to the report.

Mutual fund investment vehicles, which once dominated the DCIO space, have been losing out in DC plans to lower-priced collective investment trusts.