The Markets January 3, 2023

Alternatives Get More Consideration Heading into 2023

As traditional asset markets continue to face challenges in 2023, DC plan advisers and plan sponsors are considering alternative investments such as private real estate, equity, and infrastructure.
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Art by Changyu Zou


With the volatility that has dominated traditional asset markets for the past two years expected to continue in 2023, institutional investors are increasingly looking to alternative assets to provide yield and stability to their portfolios.

Two-thirds of institutional investors surveyed by Natixis said that they expected a portfolio that included a 20% allocation to alternatives would outperform a more traditional 60/40 investment mix. A growing number of defined contribution managers are looking toward following that lead and incorporating more alternatives into their plans as well.

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“To say that the performance of equities and fixed income has been rough would be an understatement,” says Luke Vandermillen, managing director of retirement investment support for Principal Asset Management. “That has created more interest and generated more discussions for those looking at investment lineup options.”

While the bulk of their clients remain institutional investors, Neil Brown, head of fund investor relations with the sustainable infrastructure investors Actis, says there have been more discussions over the past year with defined-contribution plans or their advisers, a trend he expects to continue.

“It’s been an unusual market in that both stocks and bonds have gone down together, so it’s been a harsh portfolio market for many investors,” he says. “Naturally that means people look at the full gamut of alternatives, including private equity, infrastructure, real estate, and more liquid strategies.”

Democratization of Alternatives

The increased interest reflects an ongoing trend toward the “democratization of alternatives,” Brown says, as the industry looks for ways to open up access to investors that may previously have not had access to them.

Another factor that has encouraged plan sponsors to expand their allocation to alternatives is the Department of Labor letter that came out in December 2021, with guidance around incorporating private equity into DC plans, including keeping such investments in a multi-asset framework run by someone who understand private assets.

“Plan sponsors are looking at how they can offer additional flexibility within plans and something that’s not correlated with the markets,” Vandermillen says.

Still, the inclusion of private assets within workplace retirement plans remains relatively low. Within target-date funds, just 9% of plans hold real estate private equity and 5% hold real estate private debt, according to PGIM, and numbers are even lower for those holding hedge funds, private equity, or liquid alternatives.

Private real estate assets are a common starting place for plan sponsors working on an alternative strategy.

“A lot of conversations center around the ability to invest in real estate and how the plan is providing access to real estate as an asset class,” Vandermillen says. “There are a lot of different flavors and a lot of different ways to do that.”

Beyond real estate, some plan sponsors are starting to look at other asset classes, including private equity, private real estate, and infrastructure, says Michelle Rappa, a managing director and client advisor with Neuberger Berman.

Reducing Volatility

“These assets may hold up a little better, and some of them can reduce volatility, so plan sponsors and their advisers are thinking about getting more diversification into a plan so that the ride is a little smoother and they have better outcomes,” she says.

Private assets may be better able to deliver on such goals than other types of so-called alternative assets, such as real estate investment trusts or emerging-market debt, that have become relatively commonplace within plans, Rappa says. Discussing those differences may be one way that advisors can add value to plan sponsors who are considering alternatives.

Todd Stewart, managing director of investment research at SageView Advisory Group, says his firm’s clients have not seen too much interest in alternatives to date, but he says that new products in the space from providers have led to conversations.

“When it comes to liquid alternatives and real assets, historically investors or plan sponsors have looked at including them as the third tier of assets in their menus, as a diversification tool for participants,” he says. “That has shifted somewhat in the last couple of years as they’re increasingly viewed as more of an inflation-hedging strategy.”

Ongoing Challenges

Still, there are several obstacles that continue to keep alternative investments out of most 401(k) plans, including platform availability, costs, and benchmarking challenges, Stewart says.

“There is also some concern about fiduciary risk that a sponsor might incur by offering these, whether that’s true or not,” he says.

Section 404(c) of the Employer Retirement Income Security Act (ERISA) does relieve some fiduciary liability for participant investment decisions if participants have enough information to make informed decisions. Plan sponsors might have concerns that it’s difficult to provide such information for alternative investments, according to experts.

For some the solution is incorporating alternatives into target-date funds or managed account offerings.

“Our research shows that there would be few participants that would be comfortable understanding that investment and making their own investment decision to allocate a portion of their retirement account to that type of investment,” Vandermillen says.

The Markets January 3, 2023

Solving the Liquidity Factor for Alternative Investments in DC Plans

Alternative investments such as private real estate create a liquidity challenge for plan sponsors, but advisers can help find solutions, or steer toward other non-traditional options altogether.
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Art by Changyu Zou


One of the main reasons that plan sponsors have been hesitant to bring alternative assets into defined contribution plans is concerns about the liquidity of such assets.

Private real estate, for example, which has become the most common alternative investment within defined contribution plans, is at its core an illiquid asset. Part of the reason that it’s a less volatile investment than traditional securities is that it’s typically only valued once per quarter, making it even harder for asset managers to create daily liquidity with it.

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However, as such alternative asset returns continue to outpace traditional investments after a difficult year, more plan sponsors and providers are looking at how they can solve for the liquidity challenge.

“First, they’re recognizing that these assets are illiquid, and there is nothing you can do to make it liquid,” says Michelle Rappa, managing director and client adviser with Neuberger Berman. “But, you can build buffers around these assets, so plan sponsors are looking at how much of a buffer do they need? Where does it need to be? Can you get the liquidity from another asset in the target-date fund?”

The liquidity profile of many alternative investments means they might not be the best choice for every plan, particularly those that have high turnover, Rappa says. For example, a restaurant plan sponsor with high turnover might need more liquidity than plans where participants are more likely to remain with the plan over the long term, Rappa says.

A Non-core Investment

In addition to liquidity challenges, many plan sponsors have concerns about the ability for their investors to understand the complexities of alternative investments, making them hesitant to add them as part of their core lineup.

“Adding alternatives on a standalone basis is challenging for most plans, unless they have a very sophisticated group of participants who understand the nuances of these investments,” says Luke Vandermillen, managing director of retirement investment support for Principal Asset Management. “The vast majority of plans probably don’t fall into that category, so they’re looking at the most effective way to package alternatives.”

For many, the best approach is adding them as part of a target-date fund or managed account structure, which provides the plan with more control over managing liquidity.

“Those vehicles don’t need to have the same daily liquidity of even a collective investment trust that’s invested in traditional fixed equity,” says Brian Collins, chief investment officer with HUB. “In a managed account structure or a target-date the liquidity can be managed within the product level, rather than at the participant level.”

That also means that larger plans tend to be the ones at the forefront of offering alternative investments in their plan. Jumbo plans with a sophisticated, in-house investment team can build custom solutions, Collins says. That’s why there’s more interest from such plans in alternatives, while small- and mid-sized plans face more challenges when it comes to incorporating alternatives on their investment menu.

In addition, larger plans are also more likely to offer managed accounts or in-plan advice options to help participants understand whether alternative investments make sense for their portfolio, and if so, the most effective way to incorporate them.

“One of the interesting things about in-plan advice products is being able to use funds in the advice solution that aren’t offered on a standalone basis in the plan,” Vandermillen says. “Then you have the best of both worlds: You’re not confusing others in the plan, but those who need it are getting professional advice and the allocation can be done for them.”

Looking for ‘Something Else’

Such advice could be helpful for participants in plans that offer Yrefy, an alternative investment that specializes in notes of defaulted private student loans. The product has a 90-day liquidity window, but there are also options for turning income on or off on investments.

Yrefy Chief Investment Officer Laine Schoneberger says the company has been receiving more inquiries from plan sponsors and their advisers interested in learning how they can incorporate the product into their plans.

“People are tired of market volatility, and they’re looking for something unique and different,’ he says. “They’re not looking at moving away completely from stocks and bonds, but they are looking for something else that might not be tied to the market.”

In addition to dealing with issues around liquidity, plan sponsors face some other challenges when incorporating alternative invetsments in their plan. For example, older, more established plans might require an amendment or other documentation to allow such products in their plan, and that means additional costs.

Another route that some plan sponsors have considered to address the liquidity challenges of alternative investments is to bring liquid alternatives into their plan. However, such investments often don’t offer the same liquidity premium enjoyed by illiquid alternatives.

“Liquid alts have had mixed success in terms of really being able to unlock value for the costs,” Collins says. “You haven’t really seen, in my experience, a big uptick in the direct DC plan market for those types of strategies.”

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