Considering Alternatives as DC Investments

The Defined Contribution Institutional Investment Association (DCIIA) released “Is It Time to Diversify DC Risk with Alternative Investments?,” which explores the potential for greater inclusion of alternative investments in defined contribution (DC) plans. “DCIIA’s interest in exploring this topic stems from the potential diversification and performance benefits offered by non-traditional asset classes and alternative strategies to a participant’s asset allocation,” said Lew Minsky, DCIIA’s executive director.

Early DC investment menus consisted of guaranteed investment contracts, large-cap equity funds, balanced funds and company stock, and then expanded to include equity funds, multiple fixed-income funds, and self-directed brokerage accounts, as well as target-date funds, the paper points out. Despite these changes, many portfolios are not diversified enough and are dominated by equity risk.

DCIIA encourages plan sponsors to provide better risk balance to reduce the volatility experienced by the typical plan participant. One solution is providing access to an asset category broadly referred to as alternatives. DCIIA believes that the potential benefits of incorporating an alternative strategy include: potential for improved total-return performance; reduced reliance on traditional equities and bonds; incremental portfolio diversification; lower portfolio volatility; increased consistency of returns.

“While the diversification and performance benefits offered by non-traditional asset classes and alternative strategies to a participant’s asset allocation are clear, the team working on the paper believes that the best way to incorporate these types of investments into a DC plan is through either an asset-allocation solution, such as a target-date fund, or through a bundled alternative-assets portfolio,” Minsky said. “In doing so, we believe plan sponsors can meet their fiduciary duty to provide better potential outcomes for their plan participants.”

In evaluating how to incorporate alternatives into their plans, the paper recommends that DC plan sponsors consider factors such as:

In evaluating how to incorporate alternatives into their plans, DC plan sponsors should consider factors such as:

• Quality of investment managers;
• Liquidity;
• Fair value;
• Leverage;
• Transparency;
• Fees;
• Participant education;
• Fiduciary responsibility;
• Legal documentation;
• Benchmarking; and
• Integration with financial advice tools.

The paper was co-authored by David Zug, Harbourvest Partners; Kevin Vandolder, Hewitt EnnisKnupp; Kurt Walten, NAREIT; Scott Brooks, Deutsche Asset & Wealth Management; and Jed Petty, Wellington Management Company. A copy of the paper can be downloaded here.