In Practice April 18, 2023

DC Plan Council Expects Increase in Real Estate Investing

Real estate allocations can strengthen participant outcomes and reduce volatility, according to the Defined Contribution Real Estate Council.

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Increasingly, defined contribution plans are adding real estate allocations to help strengthen their portfolio, according to the Defined Contribution Real Estate Council.

Defined benefit plans have long included allocations to private and public real estate, but DC plans have previously been slow to follow suit. The decline in both stocks and bonds in 2022 may be changing that mentality, as real estate assets have tended to deliver positive returns even when those more traditional investment vehicles decline, according to the council’s research.

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“There is a philosophical disconnect between what is offered to DB vs. DC participants,” the council’s report quoted Marco Merz, managing director and head of defined contribution at the University of California system, as saying. “On the DB side, we use private real estate, private equity, and absolute return strategies, but not on the DC side. As a participant in both our DB and DC plans, it makes no sense that I personally have implicit exposure to alternative assets in the DB plan but cannot access the very same exposures on the DC side.”

The council anticipates DC plans making more real estate investment, as they offer diversification according to the researchers. Historically, real estate assets have shown negative correlations to traditional stock and bond asset classes. Across a broader range of investment cycles, this can combat portfolio volatility and offer risk-adjusted return potential, the council noted.

Increasing allocations in real estate can also stabilize return profiles, according to the council. Real estate investments produce recurring cashflows from rent or lease payments, providing income which is durable and steady. In fact, while real estate is often classified as an “alternative asset,” it is the third largest asset class in the U.S., the council noted, coming in at $20 trillion as of June 30, 2021, behind fixed income at $48 trillion and equities at $47 trillion.

Real estate has helped reduce downside risk exposure when used as part of a multi-asset portfolio, the council showed through research.

“Since 2002, a traditional 60% equity/40% bond (60/40) portfolio has generated negative quarterly performance 28% of the time. During these periods, private real estate assets and REITs have delivered positive returns 90% and 70% of the time, respectively,” the report stated.

The DCREC report suggested utilizing the blended exposure of core private real estate and publicly traded REITs. Core private real estate strategies generally offer more direct exposure to the bricks-and-mortar characteristics of the asset class, while REITs provide greater liquidity but are usually more influenced by directional stock market trends over short-term periods.

Multi-asset class target-date funds and white-label funds are most ideal for adding a core private real estate allocation to DC portfolios, according to DCREC experts. Core private real estate can be held for its specific benefits. Additionally, the portfolio’s traditional asset class can satisfy potential liquidity needs.

“Overall, we see this as an exciting opportunity for plan sponsors who want to expand participant investment potential by accessing strategies that incorporate less liquid private investment alternatives, particularly private real estate,” the council wrote.

Compliance April 18, 2023

Betterment Pays SEC $9M for Misstatements Regarding Tax Loss Harvesting

The digital advice and IRA provider agreed to pay the fines without admitting or denying wrongdoing.

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Betterment LLC has paid the Securities and Exchange Commission $9 million for allegedly omitting or failing to provide “several material facts” related to tax loss harvesting services to clients, the SEC and firm announced on Tuesday. The funds are meant to be distributed to Betterment clients affected by the violations.

According to an SEC order, the New York-based digital investment firm failed to provide clients with notice of changes to contracts and did not maintain certain required books and records. The SEC alleged that from 2016 to 2019, Betterment misstated or omitted facts concerning tax loss harvesting that intended to scan clients’ accounts for opportunities to reduce their tax burden. The failures cost more than 25,000 clients about $4 million in potential tax benefits, according to the SEC.

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Betterment is among a group of digital investing and advice platforms that connect consumers directly to services ranging from robo-advised retirement accounts to cryptocurrency assets to financial education. The firm said in an online statement that the tax loss harvesting issue involved less than 1% of the total losses harvested by Betterment since it introduced the service in 2014. The median payout to each client effected is expected to be less than $100, Betterment said.

According to the SEC, Betterment went awry from the Investment Advisers Act of 1940 through actions such as failing to disclose changes in the software related to its scanning frequency for tax benefits. The regulator also charged the firm with failing to disclose a programming constraint affecting certain clients and with having two computer coding errors that prevented harvesting losses for some clients.

“Robo-advisers have the same obligations as all investment advisers to ensure they are transparent about services they provide and upfront about any material changes to those services or issues that may negatively affect clients,” Antonia M. Apps, director of the SEC’s New York regional office, said in a statement. “Betterment did not describe its tax loss harvesting service accurately, and it wasn’t transparent about the service’s changes, constraints, and coding errors that adversely impacted thousands of clients.”

The regulator also found that Betterment failed to provide advance notice of changes to its advisory contract, as well as failing to maintain accurate books and records reflecting written agreements, actions that violated its fiduciary duty as an investment adviser.

According to the SEC, the firm consented to the entry of the SEC’s order finding that it violated Sections 204, 206(2) and 206(4) of the Investment Advisers Act of 1940 and related rules.

“While Betterment reached a settlement with the SEC, it neither admits nor denies any wrongdoing,” Betterment stated. “The SEC Order acknowledges that Betterment addressed the TLH-related coding and disclosure issues by 2019. In the years since 2019, Betterment has also made significant investments to build and strengthen its compliance program.”

The firm said the settlement will be deposited into a “fair fund” that will compensate impacted customers for any potential tax benefits they missed due to the legacy issues. Those customers will be notified later this year once it is approved by the SEC.

Betterment said its tax loss harvesting services, which is provided “without additional fees,” identifies and sells holdings that have decreased in price during temporary market declines. The service has saved 275,000 customers who enabled the feature an estimated hundreds of millions of dollars, according to the firm.

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