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.
“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.