Survey Finds Limited Use of Alternative and ESG Investments in DC Plans

Plan sponsors’ view of participants’ investment sophistication and recent regulations could have something to do with it.

New research from PGIM, the global asset management business of Prudential Financial Inc., conducted by Greenwich Associates, found that despite having the ability to bring more sophisticated investment options to plan participants at institutional pricing, most defined contribution (DC) plan sponsors have chosen not to do so.

Only 13% of retirement plans offer alternative investment options as part of their target-date funds (TDFs). Just 5% of plan sponsors 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 average American worker doesn’t have access to the same types of investments currently available to institutional and high-net-worth investors,” says Josh Cohen, head of institutional defined contribution at PGIM. “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 survey of 138 DC plan sponsors found the most common reason for not including alternatives as an investment option is the need for enhanced participant education (67%). “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,” PGIM says in its survey report. “But if there are suitable investment options available, it seems all participants should have access. To the extent it is operationally feasible, DC sponsors should look to portfolios of their institutional counterparts as guidance when designing investment options.”

Other reasons cited for not including alternative investments in TDFs were operational challenges (34%), the perceived litigation risk (33%) and cost (27%). Notably, in June, the Department of Labor (DOL) issued an Information Letter sanctioning the use of private equity in asset allocation funds in DC plans. PGIM notes that the information letter did not provide a safe harbor for plan sponsors.

Plan sponsors were also asked about their use of environmental, social and governance (ESG) investments in their plans. PGIM notes that an increasing number of investors feel that ESG factors can materially affect the long-term success of a company and the returns of its securities. The survey found that nearly one-quarter (24%) of plan sponsors indicate they have taken action to incorporate ESG approaches into the plan over the past three years, while more than half (52%) said they have not. An additional 23% were neutral on the matter. There was greater interest in incorporating ESG approaches for mid-sized plans with $500 million to $999 million in assets under management (AUM).

Last year, the DOL issued a proposed rule that seemed to discourage the use of ESG investments in DC plans. However, after much pushback in public comments, it released a final rule titled “Financial Factors in Selecting Plan Investments” that emphasizes the importance of using only “pecuniary” factors in the assessment of investment options within tax-qualified retirement plans.

“While ESG is an evolving area with varying views, definitions and approaches, I anticipate investors will increasingly look to diversify their portfolios with responsible and sustainable investments. Investment options that are aligned to ESG preferences and meet fiduciary standards of appropriateness should be made available to workers,” Cohen says.

“Defined contribution [plan participants] should have access to the same types of investment strategies currently available to institutional investors and high-net-worth individuals, including alternatives and ESG investments to address their long-term investment challenges,” PGIM concludes.