Sponsors Drawn to Alternative Investments

John Hancock Investments is seeing defined contribution (DC) retirement plan clients add alternative mutual funds to their menu of investment options at a rapid pace.

“We’re seeing firms use alternatives—either as part of a target-date or asset allocation portfolio or as single additional investments in their DC lineup—to solve for three things,” Todd Cassler, president of institutional distribution for John Hancock Investments in Boston, tells PLANADVISER. “They are looking for non-correlated and diversified sources of return, a way to manage volatility and tail risk and a hedge against some type of future event, such as rising interest rates or inflation.”

Cassler explains that non-correlated or diversified sources of return are investments for which the return does not follow the movement of traditional asset classes—when the market goes down the strategy may go up, or at least drop less significantly. Tail risk is an extreme shock to financial markets—technically defined as an investment that moves more than three standard deviations from the mean of a normal distribution of investment returns.

Cassler says DC plan sponsors’ interest in alternatives is a result of a combination of lessons from the 2008-2009 financial crisis, current market volatility and anticipation of future volatility and rising interest rates. “It started in 2008 when client portfolios experienced extreme drawdowns. Firms started looking for options that would provide diversification and reduce volatility.”

Each plan is different, so the type of alternative strategy that is best depends on the plan and participants’ needs. Firms are either adding standalone alternative options like absolute return—in a retirement plan menu, absolute return funds can offer participants a way to reduce the effect of market volatility without settling for the near-zero returns of money markets, Cassler says—or adding strategies that offer a complete alternative portfolio. An example is the John Hancock Alternative Asset Allocation Fund, a fund-of-funds that invests in alternative asset classes, including, but not limited to, currencies, global real estate, commodities, natural resources, and emerging-market debt.

"Retirement plan sponsors and participants are finding multiple benefits in this all-in-one approach," says Cassler. "Because the assets are professionally allocated among multiple alternative strategies and managers, participants don't need to worry about being conversant with all the details of all the strategies. At the same time, plan sponsors are able to add this varied alternative asset category in a single, diversified option."

According to Cassler, when selecting alternative investment products for their DC retirement plans, plan sponsors need to know who is being hired, what is the performance blueprint of the strategy, what is its role in the fund lineup or target-date fund, and what are the costs associated with the product. Other questions to ask include whether there are any daily valuation issues for participants or challenging liquidity demands, as well as what is going to be the overall diversification benefit of including the product. Cassler adds mutual funds can help plan sponsors deal with these issues because they offer lower fees, liquidity and more stringent oversight not received from illiquid investments like hedge funds.

Aside from funds’ prospectuses, there are fact sheets and information about strategies and commentary about how products perform to educate plan sponsors as well as participants.