DB-Style Investment Options Growing in 401(k)s, and for Good Reason

As DC plans continue to be prevalent in the retirement plan market, 401(k) professionals should consider investment alternatives that have long been popular in DB plans, according to David Kupperman and Scott Kilgallen of Neuberger Berman.

In an article posted on NAPA Net’s Outcomes resource page, Kupperman and Kilgallen note that there are nearly 10 times as many workers with access to a DC plan than there are with access to a DC plan, but 401(k)s lag way behind their DB counterparts when it comes to investing in hedge funds, private equity and infrastructure. That is one of the main reasons, they say, why many DB plans continue to outperform DC portfolios.

Kupperman and Kilgallen write that, as a result of the growing 401(k) market, an increasing number of hedge funds are offering liquid alternatives that feature many of the same benefits that draw DC sponsors towards index funds: they have lower fees, more transparency and looser limits on investor qualification that was previously commonplace. Alternative strategies like hedge funds, the authors assert, offer plan participants more diversity, a better chance at managing volatility, and yet another avenue to ensure their plan adequately manages risk without also suppressing a chance for their portfolios to outperform the market.

The authors write that DC plan sponsors who wish to add alternate investment options to their portfolios must decide first whether they should become part of a core investment menu, or to offer them in TDFs or custom balanced funds with professional management. Target date funds allow investors, particularly younger ones, more opportunity for growth than they would get from a passively managed fund. On the other hand, adding liquid alternatives to a plan’s core allows employees who are closer to retirement age to better diversify their plans to actively mitigate their risk exposure.

The writers also highlight the importance of participant education, saying that no investment strategy is the best for everyone. Whatever alternative investment strategy an advisor chooses, they say, it should be done with the goal of pushing participants to think critically about what role they personally want to play in their own asset allocation.

Many alternatives have outperformed traditional asset classes in the past 16 years, and the authors say that these strategies are only going to become more popular.

“DB plans have demonstrated that including alternative strategies in a portfolio can enhance its risk/return characteristics,” say Kupperman and Kilgallen. “We believe this is likely to continue, especially in light of current valuations in the traditional investment marketplace and the potential for rising interest rates.”

The Outcomes library is based on content published in the June special issue of NAPA Net the Magazine. It features industry thought leaders including Sheri Fitts, PAi’s Michael Kiley, MFS Investments’ Ryan Mullen, Fiduciary Benchmarks’ Tom Kmak, Rocco DiBruno, BlackRock’s Chip Castille, Retirement Resources’ Jim Phillips and Patrick McGinn, Tom McKenna and Christopher Leone of Healthview Services, Richard Davies of AB Institutional Investments and executives from American Funds, Pentegra and Transamerica. You can browse content from the library in the “Focus: Participant Outcomes” section, in the Industry Intel tab.

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