The Markets March 27, 2014

The New Diversification: Adding Alternatives

In prior decades, international and emerging market stocks were good investments to get diversification for a retirement plan portfolio, but things have changed.
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According to Mark Peterson, director of investment education at BlackRock, speaking for a webinar hosted by Envestnet, traditional diversification vehicles underperformed when the return environment changed. Traditional stocks and bonds worked well until the 2000s. While bonds have done well since, equities have been volatile. And, now bonds will become a challenge with rising interest rates.

Peterson adds that for equity investments, correlations (the tendency for investment vehicles to move similarly in the market) have been increasing over time. Equities, including international and emerging markets, tend to cluster in the same return neighborhood with increased correlation; all equities fell during the financial crisis.

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How to Diversify Better

Risk is more than just about volatility, and alternative investments can help mitigate the different risk factors, Peterson contends.

“In a higher inflation world, floating rate or bank loan funds are a tremendous inflation hedge,” Peterson said. “Commodities are second best, and inflation-protected bonds, high-yield municipal bonds, natural resources investments, and energy investments all correlate well in higher inflation environments.”

For interest rate risk, Peterson suggests, investors consider floating rate loans or high-yield bonds. For currency risk, use global or currency investments or commodities.

“Adding alternatives widens out clustering; you get all types of returns in a bear market,” he adds.

Adding Alternatives

Peterson explains there is no standard definition of an alternative investment. “They are simply ‘alternatives’ to traditional debt and equity.” BlackRock thinks of alternative investing on two levels: via asset classes, such as commodities, currency, direct real estate, direct infrastructure, real assets and renewable energy; and via strategies—for equities, long, short or private, and for bonds, arbitrage or distressed.

Instead of just having alternative investments included in an “other” piece in a portfolio, plan sponsors should have an “alternatives” piece for different alternative asset classes, and they should split the strategies for traditional asset classes between traditional strategies and alternative strategies, Peterson suggests. He says the alternatives portion of the portfolio should be in the 15% to 20% range to make a difference, noting that adding alternatives in the last 12 to 15 years would have lowered risk and improved returns.

Manager skill is vital when selecting alternative investments and strategies—in 2012, the return difference between top and bottom managers was 13.50% versus -3.34%, Peterson says. Plan sponsors need alternatives managers with a lot of experience that can execute strategies well. Plan sponsors may spend more on due diligence when looking for the right manager, but it will pay off, he adds.

According to Peterson, the most common mistake investors make when adding alternatives to a portfolio is with the source of assets to invest. “After the financial crisis, folks were sourcing their entire alternatives allocation from equities, since equities did poorly, but equities were a buy at the bottom of market, buying alternatives at that time only reduced risk, it didn’t boost returns,” he notes. Plan sponsors should make sure their investment sourcing matches what they’re trying to do—to just reduce risk or both reduce risk and increase returns. “They may be trying to reduce risk in fixed income and boost returns for equities.”

Products March 27, 2014

Play Money: Financial Literacy as a Game

Participants might respond better to education if it’s more like a game, says Chris Whitlow of edu(k)ate, an app developer that delivers gameified financial literacy.
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Financial literacy in the 21st century should be an inalienable right, according to Whitlow, CEO and founder of edu(k)ate. “Without it, you are at a disadvantage,” he says. “Thousands of retirement plan consultants and financial advisers are in the position to tackle this problem.”

The online startup, based in Orlando, Florida, says it can boost plan participants’ financial literacy using a combination of game-like techniques and motivations, such as prizes and sponsored contests, and by drawing on the work of behavioral finance. In short, motivational techniques boost financial wellness activity.

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Gameification has gained a definite foothold over the past five or six years, Whitlow tells PLANADVISER, so creating edu(k)ate as an app to distribute financial literacy to participants using gameified techniques is viable. Users are awarded badges and points, and can participate in contests. “We can create an experience that resembles what you’d have inside a game,” says Whitlow, whose past experience includes 12 years as an institutional plan consultant.

The approach is effective, Whitlow says. The firm has seen a dramatic increase in the willingness of employees to complete financial learning. “We’ve seen more than 40% of a population go to the site, log in, think about retirement,” he says. “Once we’ve captured that email address, we have the opportunity to re-engage those folks, so we can reach out again and connect.”

Site visitors receive reminders about education units they can still complete or new courses they should think about taking. “We can use communication in a way that HR or the consultant doesn’t have time to do,” Whitlow says. 

Measuring Progress

Live in-person meetings can be expensive and time-consuming, Whitlow feels. They mostly measure employee attendance at the meeting but fail to actually engage participants or measure what they have learned. The edu(k)ate dashboard tools manage plan education, connect participants to education and measure the results of employee engagement by reports that track and communicate results.

Financial advisers with more than one plan must learn multiple processes effectively in order to distribute education and communication, Whitlow points out, since each company has a different set of tools and a different program. It can also be slightly tough for an adviser not to cross-pollinate. “If I like a course at one company,” he says, “how much of a faux pas would it be to show that course to another? So edu(k)ate tears down barriers. Here’s a way to do education the same for everyone.” The platform is agnostic, and the firm can create a designated channel on the site for a recordkeeper or vendor to put on its own education.

Whitlow says online engagement needs to be attractive and compelling for participants. The industry average for online participant engagement is currently 7% across major retirement recordkeepers, he says. One reason for this figure is that most recordkeepers have a very difficult login process, according to Whitlow. “It’s not intuitive to think that a long address is where you’ll go for your 401(k) plan,” he says. “It’s an infrequent behavior, so you forget your login password. And there is no motivation for those individuals to engage online with the recordkeeper.”

Using Incentives

Employers and their consultants can sign up on the site, then decide on an incentive. Common choices are gift cards, lunch parties and vacation days. Employees create their own accounts and start learning, monitoring the leader board that tracks “contestant” results. When the contest ends, employees receive awards, which can build camaraderie. The employer gets a report of the analytics documenting their efforts. The data is also used to make better decisions around benefits spending and reduce fiduciary risk.

One of edu(k)ate’s goals is to help employers get all employees into the plan. Even with automatic enrollment, 401(k) participation is nowhere near 100%, Whitlow says. “It should be a top priority to provide basic financial education to all employees to give them the information they need to start. Traditional retirement plan education is generally reserved for the participating employees only. Our focus needs to be on how we can help those who aren't saving start to save, and those who are saving, to save more.”

Edu(k)ate’s current numbers show that an average 40% of a workforce, or six times the national average, create an account; 21% start a course on the website, and 14% complete a first educational course. He expects the numbers to continue to improve as the site is more widely adopted.

“Most people would rather visit the dentist than go over finances,” Whitlow says. “During the financial crisis, some people wouldn’t even open their statements. It can be a very painful topic. At a dinner party, we’ll talk about almost any other topic than finances.”

More information about how the program is structured is on the edu(k)ate website.

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