There May Be a Place for Alternatives in DC Plans

A typical 60/40 equities/fixed income portfolio may no longer fit the bill, OppenheimerFunds says.

Even though the Pension Protection Act of 2006 encouraged the use of target-date funds and managed accounts, defined contribution plans may still not be properly diversified, OppenheimerFunds says in a new report, “Using Alternatives in Defined Contribution Plans.”

Because fixed income is at record low yields, the asset management firm says, “plan sponsors need additional tools to help participants cope with a more challenging market currently characterized by low rates, the potential for higher volatility and structurally lower expected returns. Alternative investments may be able to supply these additional tools to help fill the performance gap.”

Alternative assets include commodities, real estate or master limited partnerships, OppenheimerFunds says. Alternative strategies include market neutral, long/short equity or global macro. Private asset alternatives make up a third alternatives category, OppenheimerFunds says, and include investments in direct real estate, infrastructure, private equity and private hedge funds; however these are not liquid and in all likelihood are not appropriate for defined contribution (DC) plans, OppenheimerFunds says.

Next: The benefits of alternatives

Because plan sponsors are required to act prudently and in the best interests of participants when selecting investment choices for a retirement plan, including alternatives in the investment lineup can help the sponsor meet their fiduciary duties, OppenheimerFunds says. Alternatives can also potentially improve returns and help participants reach their retirement goals.

Diversification has become paramount, OppenheimerFunds says: “Sponsors, when selecting the investment lineup, need to consider the risks faced by participants—such as failing to accumulate sufficient savings, suffering major losses at an inopportune time in the savings lifecycle, or having inflation eviscerate a retiree’s purchasing power. In other words, sponsors should consider the breadth of potential benefits from allocating to alternatives aside from the obvious goal of improving total returns beyond what could be achieved through traditional style box exposures.”

Since 2008, assets in U.S. alternative mutual funds and exchange-traded funds have more than doubled and now represent 949 portfolios with $599 billion in assets under management, OppenheimerFunds says. Nearly three-quarters of advisers use alternatives, the firm says, and Strategic Insight predicts alternatives will grow at a 15% compound annual growth rate through 2017.

The best way for a sponsor to offer alternatives to participants, the asset management firm concludes, is not directly but through a balanced fund or a target-date fund with some exposure to them. Because defined benefit plans have used alternatives for decades, OppenheimerFunds expects “the availability of alternatives in DC plans to increase meaningfully over the next several years. Large DC plans have begun to include them in their plan lineups, and we expect continued penetration into mid-sized and smaller plans.”

The report can be downloaded here.