PLANSPONSOR - December 2017/January 2018 - 33

and, even for younger people, there is not
much of a return sacrifice versus stocks. "
Willis Towers Watson also favors
bond investments out of the mainstream,
O'Meara says. " The U.S. investment-grade
market is huge, but there is a lot outside
that market-other sovereign bonds,
emerging market debt, bank loans and a
lot of private credit that's held by pension
plans and endowments, but not DC plans.
Those could have a strong role, too. "
Alas, many constraints get in the way,
he says. Employee Retirement Income
Security Act (ERISA) regulations call for
daily pricing and liquidity on funds in DC
plans, and managers have to build complex
structures to make private equity and
direct real estate suitable. " There are only a
handful of sponsors that use private equity
within their DC plans, " he notes.
Several investment managers-e.g.,
J.P. Morgan Asset Management, Principal
Global Investors and TIAA-CREF-have
worked out the details on direct real estate
in TDFs, establishing a liquidity facility
that handles cash flows.
In today's industry environment,
however, the strong force working against
alternatives is fees. Vanguard Group
published a study in August on the role of
alternatives in TDFs, finding that " their
benefits remain uncertain and typically
modest " and adding that those tentative
advantages could be negated by the implicit
costs to sponsors of ensuring due diligence
on the investments, manager oversight
and additional participant education.
But above and beyond those expenses,
Vanguard's research indicated that fees
on private equity, direct real estate and
hedge funds come in above 1.5% annually
compared with fee rates above 1% annually
on commodity allocations.
" Fees are a huge focus, even with
traditional investments, " observes David
Ireland, global head of DC with State
Street Global Advisors, Boston. " Sponsors
are digging into their entire cost structure,
from their investment costs to their
administrative expenses, and that's a
concern with respect to alternatives. "
" Related are the fiduciary concerns
and fears of litigation, " he adds. " In the
aggregate, sponsors have been looking to
add investments that are lower cost and
more transparent. "
Jeff Holt, associate director, manager
research, at Morningstar Research Services
in Chicago, says the new fund series trying
to catch the sponsor's eye are not building
in alternatives. Instead, " There have been a
few factor-based funds, and there's an ESG
[environmental, social and governance]focused
target-date series. "
He notes the low uptake of alternatives,
a fact highlighted in Morningstar's
" 2017 Target-Date Fund Landscape. "
Only seven off-the-shelf target-date series
included an alternatives allocation, down
from 10 a year earlier. " There are some
that dabble in that space, but there aren't
many, and they usually allocate just a few
percent, so it's hard to see that the alternatives
would make a significant impact on
their returns, " he explains. These funds'
allocations fall into such categories as longshort
credit and equity, and multi-alternative
strategies. Putnam's RetirementReady
series is an outlier, allocating, as of
December 2016, over 20% of fund assets
to absolute return strategies.
" I think there's a middle ground to
alternatives that has not been explored, "
offers Ireland. " In our index-based targetdate
funds, we use global REITs, commodities
and long Treasury bonds. These are
diversifying asset classes but without the
liquidity and transparency baggage of the
high-cost alternatives. During the financial
crisis, physical long Treasury bonds
were up about 20% against an equity
market that was down about 40%-a
simple solution for downside protection.
Plan sponsors should be looking at the
entire opportunity set, beyond the traditional
market-cap weighted indices, or the
stuff that may not be attainable. "
Planning for Inflation
Although not viewed unanimously as an
alternative, the most prevalent nontraditional
investment in TDFs, and in
core menus as well, is inflation-sensitive
assets.
" When was the worst time to retire? "
Ireland says. " It was the 1970s, when
people on a fixed income saw 70% of their
purchasing power wiped out by rapid
inflation. " Notwithstanding this experience,
inflation is one of the most underrepresented
risks in DC plans, he notes.
" Under 3% of assets are invested in inflation
protection, and it is highly skewed to
TIPS [Treasury inflation-protected securities],
which have a low beta to inflation. "
To protect a portfolio against rising
prices, there is no magic bullet, because
each bout of inflation is different and
unpredictable, says O'Meara. Accordingly,
many consultants and providers prefer an
approach that takes in several inflationsensitive
assets: real estate via REITs,
TIPS, commodities futures, and equities
in infrastructure and natural resource
companies-whose revenues and profits
should benefit from rising inflation.
If the current market climate holds,
alternatives as a group will probably be
slow in gaining traction. " The hope for
an alternative strategy is that it can prove
it has a better risk-return proposition
than what's already out there, " says Holt.
" Contrast that with the multi-year equity
rally we are in, and it's natural that there's
little appetite for something other than
equities. In this environment, that's a
headwind for alternatives. " -John Keefe
KEY POINTS
* Including alternative assets
within TDFs could add
diversification or higher returns.
* ... But alternative investments
have higher fees than mutual
funds, are illiquid and are hard
for trustees to govern; therefore,
they may be a bad fit for TDFs.
* Inflation-sensitive assets are
a prevelant nontraditional
investment in TDFs, but how well
they work is hard to gauge.
PLANSPONSOR.com December 2017-January 2018 33
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