For defined contribution plan sponsors, alternative investments have become increasingly common.
Mega plans—with assets in the billions and hundreds of millions—were historically more likely to include alternatives such as core private real estate. The asset class was most prevalent among large corporate plans, but that has evolved, explains Jani Venter, executive director, defined contribution fund management, real estate Americas at JP Morgan.
“Historically, it’s been large corporate and public plans with custom structures that made the decision to include real estate, because of the asset class benefits,” she says. “There’s also a smaller component of investors holding exposure through core menu white-label funds or operating portfolios.
She adds that public DC 457 plans have also increased access to alternatives.
Plan Prevalence: TDFs Dominate
Plan sponsors are including alts like private real estate through multi-asset strategies situated within target-date funds, says Jennifer Perkins, managing director and defined contribution portfolio manager at LaSalle Investment Management.
“Multi-asset strategies are the biggest accumulator of assets within defined contribution plans; by and large, the target-date fund,” she says.
She explains that alternatives’ inclusion within DC plans is growing.
“The increased use of outsourced CIOs from the consultant community is also a way in which plan sponsors are using white-label funds that consultants would put together through their OCIO teams,” Perkins says.
Venter explains that the largest growth for private real estate alts in DC plans is from plans that operate under the Employee Retirement Income Security Act, a 1974 federal law governing defined benefit and DC plans.
“Our DC real estate solutions are only available to qualified plans, so as a result we’ve experienced most growth from ERISA plans,” she says.
ERISA sets minimum standards for retirement plans’ participation, vesting, benefit accrual and funding, and requires accountability of plan fiduciaries.
Plan fiduciaries are defined as anyone who “exercises discretionary authority or control over a plan’s management or assets, including anyone who provides investment advice to the plan,” according to the Department of Labor.
Fiduciaries who abrogate ERISA’s dual principles of loyalty and prudence to plan participants can be held responsible for restoring losses to the plan, and participants have a right to sue the plan for benefits and breaches of fiduciary duty. While public 457 non-ERISA plans have also included real estate, “it’s mostly the ERISA plans as the market has evolved to this point,” Venter explains.
For plan sponsors that are interested in but have not implemented alts, the greatest inhibitor has been and remains fees, according to Venter. Excessive fee claims often feature in ERISA lawsuits against retirement plan sponsors.
In an era of cost compression among major investment product providers, Venter says, fees have decreased.
“The biggest concern is the fee impact because we’ve been in a market environment where fees compressed significantly in the post Great Financial Crisis cycle and stocks and bonds performed stronger than anyone expected, Venter says. “That era of post-Great Financial Crisis growth is over and you’re looking at solutions that offer the potential for growth in a portfolio, but you have to decide how active and how passive will your solution be to balance out the impact of fees.”
Fees and liquidity have been “a couple of the inhibitors to date,” Perkins adds, “because of the sheer amount of people and the number of boots on the ground that are needed to run an effective and high-performing private real estate offering. There’s a lot of human capital that’s involved with that that then comes with a higher fee for the investment offering itself.”
Venter urges plan sponsors interested in private real estate to find the right fee figure, as the headline cost of the asset class can be misleading. She says that plan sponsors should examine and present the investment fee by incorporating the cost of the investment with the total return, net of fees, to obtain a clear picture of the value for participants.
“The way you get them comfortable with that is you expand the conversation to [clarify] where the money is coming from,” she says. “What is your access budget? Once that conversation is undertaken, it’s very tangible for plans to move forward and understand that their fee concerns are relevant, this makes sense and any litigation that’s coming out of that is noneventful.”
Plan Sponsors’ Path
For plan sponsors looking to include alternatives in DC plans, the past may prove prologue.
The rising interest rate environment and down market for equities mean that new plan participants, near-retirees, and retirees must protect their retirement investments from “a strong inflation number,” says Perkins.
The purpose of private real estate in plans is “diversification first and foremost,” she says, “but private real estate can be really helpful with inflation because of the inflation-hedge effects.”
Plan sponsors may be looking afresh at alternatives and private real estate to help boost participants’ returns.
“The last decade, it has really been pretty easy for people to save for retirement with the bull equity market that we have experienced with not a whole lot of volatility,” she says. “It was nice to see the run up in your retirement savings through that time period.”
Perkins notes that “it looks a little bumpier [now], and we’ve experienced some of those bumps as of late, so just highlighting the importance of diversification and lower risk strategy is pretty compelling at this particular time in the market.” She cites this as a reason “for professional multi-asset solutions providers … to incorporate private real estate and alts in .”
To protect participants’ retirement assets and help to improve their retirement readiness, employers may want to investigate the history of DB plans and borrow from the pension management playbook, she says. “The institutionalization of real estate as an asset class in the late 70s and early 80s really came about as defined benefit plans, at that point in time, were looking for an inflation hedge,” she explains.
Plan sponsors may also be enticed by the increased risk-adjusted returns of using private real estate. It can be a “great inflation hedge, [which is] particularly of importance in today’s environment,” Perkins adds.
DC plan sponsors have traveled a winding road since the 1970s—and when it comes to alternatives and private real estate, she says, that road might lead right back to the beginning.
“With private real estate having served the defined benefit community [as] an inflation hedge, which kickstarted the asset class from an institutionalization standpoint, [it] feels a little bit like déjà vu now in terms of people trying to figure out how they’re going to protect their retirement investment,” Perkins explains.