The Markets October 22, 2015

TDFs Can Be the Vehicle for Alternatives in a DC Plan

A white paper discusses some of the ways plan sponsors can put alternative assets into a DC plan.
Reported by

As plan sponsors search for ways to find value and diversify asset classes in their defined contribution (DC) plans, many have considered offering alternative assets as an option. These assets provide the benefits of diversification and low correlation to traditional asset class performance. However, concerns about the scalability, liquidity and valuation needs of DC plans have inhibited their use as a viable investment option.

In “Adding Alternatives to DC Plans,” Northern Trust explores the operational and plan structure options available to plan sponsors that wish to include alternative assets in their plans.

Want the latest retirement plan adviser news and insights? Sign up for PLANADVISER newsletters.

Three possible solutions—target-date funds (TDFs), a combining of defined benefit (DB) and DC assets into a unitized structure, and indexation—are explored in the paper.

Target-date funds are one of the best ways to incorporate alternative asset classes into DC plans, says the Defined Contribution Institutional Investment Association (DCIIA), which also recommends using a bundled alternative assets portfolio, or adding alternatives on a standalone or index basis.

White labeling, or moving away from brand-name mutual funds to more generically named ones customized to a specific defined contribution plan, is a path that is gaining traction among these plans. It can increase the plan’s flexibility, help it cut costs, streamline investment menus and reduce participant confusion over investment choices. This approach can also let plans use their existing plan managers and potentially achieve higher alpha.

Alternative assets are increasingly held inside target-date maturity funds, including white labels. Commingled DB/DC structures are increasingly used to house more alternative investments—real estate investment trusts (REITs), currencies and commodities wrapped into investment vehicles such as hedge funds, private equity, mutual funds, exchange-traded funds (ETFs) or separate accounts. This also can be structured so that the alternatives are excluded from the cash flow of the target-date fund, which is necessary because alternatives do not accommodate daily liquidity.

According to Tom Lauer, defined contribution asset servicing consultant at Northern Trust, a number of clients want to put alternatives into TDFs for their defined contribution plans but for various reasons can’t get it done. Some solutions can allow these clients to work around perceived challenges.

Clients ask about the best methods for dealing with liquidity and valuation challenges as interest in including alternatives has increased, Lauer says. “We tell our clients that there are ways to structure their plans that allow them to take advantage of alternative assets,” he says. “Some clients find it appropriate to integrate defined benefit and defined contribution plan assets in order to leverage scale and provide participants with access to alternatives.”

“The key to increasing the mix of options plan sponsors offer is having a well-defined operational strategy that focuses on the needs of the plan participants,” says Pete Cherecwich, head of corporate and institutional services in the Americas at Northern Trust.

“Adding Alternatives to DC Plans” can be downloaded from Northern Trust’s website.

The Markets October 22, 2015

Empower Cites Strong Benefits for Managed Account Users

Several large-volume retirement plan providers have recently published research highlighting strong performance in clients’ managed accounts.
Reported by

Participants making use of a managed account product often see long-term portfolio returns in excess of those realized by participants who do not use managed accounts, according to new research from Empower Retirement.

Empower Retirement President Edmund Murphy III tells PLANADVISER he is personally very excited about the new research, published under the informative title, “The Haves and the Have-Nots.”

For more stories like this, sign up for the PLANADVISERdash daily newsletter.

“I really think it’s a fresh new look into the opportunities presented by managed accounts,” he suggests. “Personally, I haven’t seen any research out there that more clearly and concisely makes the case for managed accounts. The findings are very compelling and show that managed accounts make a lot of sense from both the investing and fiduciary/cost perspective.”

Some of the topline findings make managed accounts look quite compelling indeed. Over a five year period from 2010 to 2015, Empower says managed account users enjoyed an additional 2% in average annualized returns in defined contribution (DC) plan accounts compared with those who do not use an investment allocation product. Specifically, Empower says managed account users secured a 9.77% annualized return net of fees between 4/1/2010 and 3/31/2015, compared with 7.85% for plan participants controlling their own asset allocations.

“Critically, these figures are net of fees,” Murphy explains. “We all know the focus on fees in the retirement planning industry has been a net positive for plan participants, but one thing to keep in mind is that outcomes matter just as much as pricing. We need to look holistically at returns and fees and look for opportunities where the fees may be a little higher but the performance is there to justify it.”

For this report, Murphy says a managed account is defined as a participant’s retirement plan account “which is managed by a registered investment adviser.” Different firms approach managed accounts different ways, Murphy adds, but “we’re looking in general at situations in which the investment adviser analyzes the funds available in the retirement plan and, using additional information supplied by the participant, produces a portfolio to help the participant meet his or her retirement goals.”

NEXT: Controlling emotion via managed accounts

Murphy says another key point in the research is that managed accounts can help participants “take the emotion out of investing and help gain the confidence they need that the investments in their retirement plan are properly allocated.”

He says the study’s analysis shows the variance in performance consistency between the highest and lowest performing portfolios was “so much smaller for managed account users than it was for those who did not utilize such a product,” at 3.93% variance versus 11.41% variance, net of fees.

According to Empower, the variation in these annualized returns for participants not using a managed account “may attribute to underperformance over the five-year period studied.” Evidence in the study suggests that the variance may be an influential aspect of what determines annual average returns over long periods of time.

The report also offers a historical perspective of product development in the defined contribution space leading to the rise of managed accounts. A key benefit that has led to lasting popularity and innovation for managed accounts, the study says, is that as participants age their assets are re-allocated based on personal factors.

“Periodic market shifts are addressed through regularly scheduled asset allocation changes based on an individual’s information and risk tolerance,” Murphy says. “The goal is to help keep their customized strategy on track. It’s an investment approach that takes emotion out of the equation, and one that may help mitigate investment performance swings over time.”

The study was conducted by Empower in conjunction with its subsidiary Advised Assets Group, LLC, a federally registered investment adviser. The full report is available online here. 

«