Use of Liquid Alts in Defined Contribution Plans is on the Rise

Use of Liquid Alts in Defined Contribution Plans is on the RiseTraditionally, a defined benefit pension was seen by most Americans as an important component of the American Dream. Workers would begin with an employer right out of high school or college, with every intention of working with the same firm until retirement, at which point they’d receive guaranteed retirement benefits.

Global realities started catching up with the American Dream in the 1970s, and the shift towards defined contribution plans – such as the 401(k) – accelerated in the 1980s and 90s. Unlike defined benefit plans, defined contribution plans guarantee contributions to a retirement account, but they do not guarantee future retirement benefits if the account’s investments don’t perform.

Today, defined contribution plans are the norm in the United States, while defined benefit plans are being closed and are slowly declining in their overall availability to employees. There are pros and cons to each kind of plan, but up until recently, defined benefit plans had a distinct and unfair advantage in that they could invest in alternative investments, whereas defined contribution plans were largely restricted to traditional stock and bond investments. Thankfully, liquid alternatives have provided a solution to this disparity.

Alternative Funds as DC Plan Options

Back in February, John Hancock Investments issued a statement saying its defined contribution clients were “adding alternative mutual funds to their menu of plan options at a rapid pace.” Between 2012 and February, 2014, more than 400 plans added John Hancock’s alternative strategies, including the John Hancock Global Absolute Return Strategies Fund and the John Hancock Alternative Asset Allocation Fund.

According to Todd J. Cassler, President of Institutional Distribution for John Hancock Investments, retirement plan sponsors are finding multiple benefits in the “all-in-one approach” of investing in multi-manager alternatives funds, rather than individual alternative investments. “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.”

The Endowment Approach

John Hancock Investments isn’t the only firm touting the expansion of alternative investments in defined contribution plans. Last week, the Alta Trust Company and ETF Model Solutions announced the launch of the Endowment CIF (Collective Investment Fund), which is designed to emulate the strategies of endowments, pension funds, and defined benefit plans. But instead of investing in illiquid alternatives like limited partnerships and private placements, the Endowment CIF will use alternative ETFs and mutual funds to obtain its alternative allocations.

Collective Investment Funds (CIFs) are pooled investment vehicles that are only available to qualified investment plans, but they’re otherwise similar to open-ended mutual funds. ETF Model Solutions says the Endowment CIF offers reduced portfolio volatility due to its inclusion of alternatives, which have little correlation to the stock and bond markets. The fund is designed to have roughly 40% of its assets allocated to global stocks, 20% to global bonds, and 40% to liquid alternatives.

The Alta Trust Company, which sponsors the Endowment CIF,  has selling agreements with most retirement-plan platforms, which means that most advisors will be able to offer their clients exposure to the Endowment CIF through existing platform relationships.

Alternatives in Target Date Funds

According to T. Bondurant French, a CFA with Adams Street Partners, target-date funds are the largest growing segment of the defined contribution plan market today, and they are a good fit with alternative investments. “I don’t see most individual participants having enough expertise or education to make choices on a monthly or quarterly basis between high yield, global fixed income, global equity, hedge funds, commodities, real assets and private equity. But those options do make a lot of sense in a professionally managed strategy like a target-date fund.”

A 2014 PIMCO survey found that 98% of consultants support or strongly support use of alternatives within target-date strategies.

Mr. French participated in an August 5 round-table discussion on the use of alternatives in defined contribution plans, along with Robert Capone of BNY Mellon and David Skinner of Prudential Real Estate Investors. The three gentlemen all projected increased use of alternatives within defined contribution plans, with Mr. Skinner saying, “Alternatives are becoming attractive to plan sponsors who are seeing the potential to deliver better outcomes in the long run by addressing the three key themes of dampening volatility, protecting the downside, and reducing the potential impact of inflation.”


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