says David O’Meara, senior investment consultant at Willis
Towers Watson in New York City. “That includes anything
that might not be found in a traditional 401(k) structure.
[Such investments] don’t have all of the attributes of the
private market assets, or all the bells and whistles of hedge
funds, but they are different enough to diversify a conven-
Inflation protection has been the major theme in DC
alternatives, through various approaches to “real assets”
that shelter participants’ hard-won savings from rising
prices. Many target-date funds include a real-asset sleeve
that contains a combination of REITs, commodities, TIPS
[Treasury inflation-protected securities] or the stocks of
infrastructure and natural resource companies.
“We’ve also been seeing an inflation-protection option
in the core menu,” notes Jeri Savage, head of DC research
and a partner at Rocaton Partners in Norwalk, Connecticut. “That can take various forms and include several
asset classes, and [also] be an all-weather type of inflation
protection,” she explains. “All else equal, we would rather
see our clients offer a multi-asset approach in their core
menus,” to avoid the potential volatility of single options.
Such multi-asset core menu choices are offered by John
Hancock, Franklin Templeton, Principal Investors and
Deutsche Asset Management.
Less developed are so-called “liquid alts”—specialized
strategies resembling those of hedge funds that invest in
long-short equity and credit, market neutral equity, curren-cies and various multi-alternative combinations. Other
alternatives invest in equity factors—aka smart beta—
such as value, momentum, quality and carry.
In its newly published whitepaper “2017 Target-Date
Fund Landscape,” Morningstar points out that liquid alts are
still fairly scarce within target-date funds, and the number
of series holding alternatives dropped from 10 last year to
seven this year. Moreover, allocations of those including
liquid alts are rather small. “Their generally high fees make
them a hard sell for the fee-sensitive target-date fund
space,” Morningstar writes. However, hundreds of hedge
funds have rolled out ’ 40 Act [1940 Investment Companies
Act] versions of their strategies, although adapted to meet
mutual fund regulatory requirements.
Judging the success of liquid alts—or any alternative,
for that matter—is challenging, concedes Ross Bremen,
partner at consulting firm NEPC in Boston. “Alts work,
but [having] success at a complex strategy and having the
highest possible returns are not synonymous,” he explains.
“The reality is that when the market has built products
that behave differently from the majority, investors tend to
follow the ‘hot dot’ with the highest return. Some products
can minimize losses or volatility in a portfolio, but those are
not the products the market has gravitated to.”
“Sponsors and advisers need to be mindful of the envi-
ronment returns are generated in,” notes O’Meara. “A fund
may have underperformed equities over the last three
years, but if it was behaving as it was designed to, that’s not
necessarily a bad thing. The test of alternatives will come
when the equity markets aren’t so hot.”
Liquid alternative funds also face an uphill battle
regarding fees. “There are reasonably priced liquid alts,
but you won’t find any with a fee as low as that on an S&P
[Standard & Poor’s] 500 index fund,” observes Matt Rauseo,
vice president at AQR Capital Management in Greenwich,
His colleague Antti Ilmanen, manager of AQR’s port-
folio solutions group, cautions that sponsors and advisers
should look beyond the headline fee of a strategy. “A smart
beta portfolio starts with a long-only market exposure,
which you can get for zero to 10 basis points [bps], and
then combines factor tilts, which can be very valuable,
say, worth 30 basis points,”
Ilmanen says. “Long-short
are giving you even more.
If they were available at
50 basis points, that would
clearly be a better deal,
because it doesn’t include
any of the beta, which is
worth very little in terms of
Rauseo lays out three
crucial points for plan spon-
sors or advisers to consider
in choosing any alternative
asset: “They need to under-
stand the concept behind
the investment and how it is likely to behave in a range of
markets. First, does it clear the bar for risk-adjusted return?
Can it enhance return or reduce portfolio risk, or possibly
both? Second, it should improve performance in bad times.
That is, it should do less badly than the rest of the portfolio,
or perform well.
“Third, versus stocks and bonds, will this asset perform
better in a broader range of macroeconomic environments?” Rauseo says. —John Keefe
• In light of expected lower returns in the equity and
bond markets, defined contribution plans might
consider diversifying investment menus to include
funds that invest in alternatives, similar to what
defined benefit plans have used to improve investment
diversification and returns.
• Alternatives may be difficult to put as stand-alone
investments due to liquidity issues, so advisers can
look for funds that allocate to them.
• Some target-date funds invest in real estate, REITs,
commodities, TIPS, and infrastructure and natural
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