Plan sponsors remain hesitant to add alternative asset classes to their target date funds (TDFs), but a new paper argues that such investments might be one way to improve the success of DC plans.
Survey results from PGIM find that only 13% of retirement plans offer alternative investment options as part of their TDFs. The most common reason cited for not including alternatives is the need for enhanced participant education (67%). This is followed by operational challenges presented by using alternatives (34%), perceived litigation risk (33%) and cost (27%). What’s more, 28% of respondents said they don’t believe in alternatives from an investment perspective.
PGIM canvassed more than 130 DC plan sponsors to learn about the current trends in the DC market. The research was conducted by Greenwich Associates from March 5 through July 17, 2020, using an online, quantitative approach with DC plan sponsors that have at least one 401(k) plan and a minimum of $100 million in 401(k) assets.
The study found that within the TDF arena, just 5% of plans say they currently offer or are considering offering hedge funds to their participants via their TDF, while 7% currently offer or are considering offering private equity. Real estate private equity has the support of 11% of plan sponsors.
The research further reveals that more larger plans are offering TDFs with alternative investment options embedded in their offerings, and real estate is a main component. Of the plans surveyed with between $1 billion to $5 billion in AUM, 19% say real estate private equity are offered within their TDFs.
ESG Interest
When asked about their ESG use, PGIM found that nearly a quarter (24%) of plan sponsors indicate they have taken action to incorporate ESG approaches into their plan over the last three years, while more than half (52%) said they have not. An additional 23% said they were neutral on the matter. Directionally, the research found that there is greater interest in incorporating ESG approaches among mid-sized plans with $500 million to $999 million in AUM.
The report emphasizes that ESG investing is of continued interest for investors in the U.S. and is an evolving area with varying views, differing definitions, and new research is being unveiled on a regular basis. Moreover, it notes that the DOL issued its final rule requiring plan fiduciaries to select investments based on pecuniary factors, but that the Biden administration is expected to revisit the current policy.
The Case for Alts
Despite the overall lack of availability, Josh Cohen, head of institutional defined contribution at PGIM, argues that DC plans may be a good starting point to effectively deliver ESG and alternative strategies, as they offer the fiduciary oversight, institutional pricing and a long-term time horizon. “The average American worker doesn’t have access to the same types of investments currently available to institutional and high-net-worth investors,” says Cohen. “In a world where we are experiencing changing demographics, aging populations and issues of inequality, it is imperative that individual investors have access to quality investments to help them build and maintain their wealth, particularly when it comes to retirement.”
The report observes that the lack of alternatives use is, at least in part, a function of sponsors believing that, because most participants are “novice investors,” they should not have exposure to more “sophisticated” investments that other institutional investors often use. “But if there are suitable investment options available it seems all participants should have access,” the report contends, adding that to the extent it is operationally feasible, DC sponsors should look to portfolios of their institutional counterparts as guidance when designing investment options.
Moreover, the report observes that one of the biggest drivers of the trend toward the simple approach in DC plans has been perceived litigation risk. “Ironically, one could argue that the trend of moving towards simpler and cheaper investment menus actually creates more legal risk by putting sponsors’ interests ahead of participants’ interests,” the report argues.
Additionally, it notes that the Department of Labor’s stance on the use of private equity in DC plans has changed, giving plan fiduciaries the opportunity to take a more innovative approach. “Whether it’s private equity, other alternative strategies or any investment strategy, a fiduciary should be able to go through a process and rely on their own expertise and the expertise of their advisors to evaluate whether they believe a strategy will benefit their participants,” Cohen suggests.
“The Evolving Defined Contribution Landscape: Alternatives & ESG as Long-Term Solutions for Long-Term Challenges” is the second of a three-part series by PGIM on the evolving DC landscape.
