PSNC 2010: Outside the Box(es)

August 3, 2010 ( – Defined benefit plans use alternative or non-traditional investments to hedge against risk, but recently defined contribution plan sponsors are also seeking this diversification.

Laurie M. Tillinghast, Senior Consultant, NEPC LLC, explained to attendees at the PLANSPONSOR National Conference that the role of alternative investing is to reduce overall risk – and enhance overall return – by incorporating into a portfolio uncorrelated asset classes, ones that don’t move in same direction as stocks and bonds. Tillinghast noted that while DBs use alternatives such as hedge funds and private equity, these have typically not been compatible with DC plans because there is no daily valuation, no daily liquidity, and no transparency.  

Alternatives for DC plans often include equity alternatives and fixed income alternatives; commodities; real estate, natural resources, and high yield investments; emerging markets equities; and Treasury Inflation Protected Securities (TIPS). However, Tillinghast noted that these are very complicated, hard to communicate investments, so they should not be offered as core investments in plan, but are better used in target-date or risk-based investments, or managed funds.  

According to James A. Sia, Director, Defined Contribution, Wellington Management, the proliferation of investment choice in DC plan menus has been a disservice to participants, so he agrees that packaging non-core assets for participant is a good idea to help them diversify. Sia added that, in the DC market, plan design is deficient in protecting against purchasing power erosion over time, so sponsors should add inflation protection products to the package they offer participants. Sponsors can also put employer match or other employer contributions in custom created target-dates to provide diversification to participants’ account balances.  

Richard A. Davies, Head of Product Strategy, AllianceBernstein, said that although plan sponsors are more comfortable with strategies that are valued daily, they should consider other less liquid products such as derivatives and hedge funds that are used for DB plans. Davies said he thinks the industry will see some interest in this since the market downturn, and limiting participant transfers or distributions to four times a year, as plans did in the past, is really a best practice for long-term investing.  

“If investments look good for long-term portfolios such as DBs, sponsors should consider them for target-dates,” Davies said. However, he warned that sponsors should make sure pricing is fair since the design of certain investments, such as private equity, require higher costs up front and more benefits later. Davies also reminded sponsors that as a fiduciary, they should understand and monitor the underlying investments within a packaged product.  

Audio of the panel discussion is here.