PLANADVISER - March/April 2019 - 51

Lee, co-portfolio manager of target-date strategies at T.
Rowe Price Group, Baltimore. " Several years ago, we did a lot
of research on alternatives in a target-date fund [TDF] and
demonstrated that, with a reasonably sized allocation, you
could improve portfolio construction and diversification.
" Different alternatives could be beneficial at different
points in the glide path, " he adds. Private equity, which can
earn higher returns than public equity, would make sense for
people early in their careers, who could hold it over the long
term. Commercial real estate is coveted for its steady returns
and low correlation with public equity. " The fund of hedge
funds we use tends to have a relatively low volatility, almost
like that of investment-grade fixed income, and I could see
using that as participants get closer to retirement, " he says.
So far, DC-feasible solutions for private equity have yet to
take root, but exposure to real estate comes in several forms
such as commingled funds that invest directly in commercial
real properties, as well as real estate investment trust
(REIT) funds that buy shares of public real estate companies.
" Direct real estate is truly an alternative asset class,
and a better diversifier than a public REIT fund, " says Greg
Hobson, senior financial adviser at Greenspring Advisors, in
Towson, Maryland.
J.P. Morgan Asset Management is one of the industry's
largest managers of direct real estate for institutions and
that firm has long included it in its TDFs. " We have a neutral
position of about 7% throughout the glide path, " Lester says.
" It provides volatility management early on, when investors
have a lot of equity. At the end of the glide path, it's a consistent
source of income, as it pays stable and predictable
yields. The real estate component has been a true source of
added value throughout the life cycle, and it manifests in a
much higher Sharpe ratio. "
The illiquidity gets in the way, however, and the direct
real estate exposure is available in TDFs only in collective
trust form. " We've chosen to not pursue putting direct real
estate into a mutual fund because of the liquidity and fee
considerations, " she says.
At T. Rowe Price, Lee says, public REIT exposure is seen
as an effective rival of the private sort. " Our real estate team
found that REITs have delivered the same kind of long-term
return as direct real estate, once you adjust for leverage, and
for smoothing in valuation, " he says.
It is not a simple question, though. The table compares
Topics for the Next Committee Meeting
* How alternatives unaffiliated with mainstream equities
and bonds can provide much-needed returns during
market declines and can smooth out volatility.
* If the committee is interested in offering alternatives,
does it think the best way is through a TDF
that includes these asset classes?
* Alternatives can include commercial real estate,
REITs, private equity and infrastructure, as well
as hedge funds; are there certain alternatives the
committee would like to avoid?
the returns of direct real estate and REITs over several time
periods, as well as the Standard & Poor's (S&P) 500 and a
balanced portfolio of stocks and bonds. Returns on direct real
estate are quite steady, while the record of REITs looks more
like that of stocks and for these periods is just as volatile.
Another source of nontraditional returns in DC plans
is real assets, which can react more in line with inflation
than do stocks and bonds and better protect participants'
purchasing power. Whether they are really alternatives-
and how to implement them-is up for debate. " We definitely
believe in inflation-sensitive assets and use them in
every TDF glide path, " says Jacob Tshudy, director of defined
contribution investment strategies at SEI in Oaks, Pennsylvania.
" It might be in TIPS [Treasury inflation-protected
securities], and, in all but one client plan we have a multiasset
product that includes commodities. " Such funds can,
additionally, include public equities of natural resources
and infrastructure companies.
" We also include TIPS in the core menus of most clients,
as they are not necessarily a risky product, " Tshudy explains.
" But commodities are something we include only in a fund
we manage, so individuals can't invest too heavily in something
that can be very volatile. "
The dyspeptic markets of last year, with a sharp drop in
equity values in the fourth quarter, provided a proof of the
benefit of alternatives, Lester says. " Direct real estate valuations
were stable, and investors got a total return of 7% to
8% from the current income. In those sorts of markets, it's
like a bond on steroids. " -John Keefe
Traditional and Alternative Asset Classes
Annualized returns and standard deviation, for periods ended December 31, 2018
Return
Index
Public real estate: Wilshire REIT Index
Direct real estate: NCREIF ODCE Index
S&P 500
60% S&P 500/40% Bloomberg Barclays Aggregate
Source: eVestment
1-year 3-year 5-year 10-year
2.1%
-4.8%
8.4%
-4.4%
-2.4%
7.8% 12.2% 16.1%
Standard Deviation
1-year 3-year 5-year 10-year
9.8% 12.7% 22.4%
8.2% 10.4% 7.0% 0.4% 0.4% 1.4% 7.5%
9.3% 8.5% 13.1%
6.5%
6.2% 9.4% 10.5% 6.5%
18.3% 11.0% 9.8% 14.3%
5.8% 8.4%
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