JM Family Enterprises Inc. added less liquid investments to the three custom risk-based asset allocation funds of its $320 million 401(k) plan and to its $599 million profit-sharing plan for diversification and “improving our overall risk and return combination,” said Ronald Virtue, Deerfield Beach, Fla.-based director, investments.
All assets in the profit-sharing plan are invested in a multiasset-class portfolio. The majority of assets in the 401(k) plan are invested in the risk-based asset allocation funds, Mr. Virtue said. He declined to provide the exact percentage. The less-liquid investments in both plans are direct real estate, hedge funds and global sovereign debt.
The other asset classes the risk-based funds and profit-sharing plan invest in are domestic, international and emerging markets equity, commodities, domestic fixed income, global tactical asset allocation and a small amount of cash.
Mr. Virtue said the investment team tries to keep “daily liquid structures as the vast majority” of the allocation.
And even for the less-liquid investments, the investment team tried to obtain “the best liquidity available,” he said.
For example, the company's $353 million defined benefit plan and 401(k) plan have the same direct core real estate manager — J.P. Morgan Asset Management (JPM) — but for liquidity purposes, the fund structure and combination is different in the defined contribution plans.
“The fund in the DB plan includes a queue for investors to add new cash. The fund in the DC plans regularly sits in the queue making small flows in and out of the larger core real estate fund easier,” Mr. Virtue said. An allocation to real estate investment trusts and line of credit in the DC version also helps with liquidity, he added.When it came to incorporating the direct real estate portion, the investment team “spent a lot of time understanding pricing, reconciliations and audits,” Mr. Virtue said. “We also needed to do more modeling in-house to make sure daily liquidity limits would not be an issue for us.” “A portion of the core real estate fund is available on a daily basis, so it satisfies the daily requirement for the record keeper, but we realize not 100% of the fund is available on a daily basis,” Mr. Virtue noted. Fidelity Investments is the record keeper. Direct real estate was added to the 401(k) plan and profit-sharing plan in 2012. Hedge funds were added to the 401(k) plan's risk-based funds in the first quarter of 2017 and to the profit-sharing plan in 2012. The profit-sharing plan's hedge fund allocation was increased in 2016.
Both the profit-sharing plan and 401(k) plan are invested in a multistrategy hedge fund mutual fund with daily liquidity (the same manager runs a multistrategy hedge fund in the DB plan with monthly liquidity). The profit-sharing plan is also invested in a commingled hedge fund of funds that does not have daily liquidity but does have daily pricing, Mr. Virtue said. He declined to provide manager names and allocation sizes.
To further illustrate how the DB plan and DC plans' hedge fund exposure differs, Mr. Virtue said that a hedge fund strategy in the DB plan has individual long/short positions in stocks, while the 401(k) or profit-sharing version uses futures or swaps “so everything can be wrapped up quickly.”
Mr. Virtue declined to provide performance data but said the less-liquid investments have “performed as expected and have provided diversification.”
Direct real estate was one of the defined contribution plans' top-performing allocations in 2015, and helped offset the decline in international equities in 2015 from the strong U.S. dollar, Mr. Virtue said.
Mr. Virtue declined to provide fee data, but said the 401(k) plan's fees “are very competitive for a plan of our size, despite having a broader mix of asset classes.”
On whether the defined contribution plans would eventually include private equity, Mr. Virtue said the asset class could eventually be added, but a lot of questions remain.
“One item that has been an issue for our ERISA counsel revolves around performance fees” for private equity, Mr. Virtue said. “So far, we've been able to access hedge funds without performance fees.”
The effects of adding liquidity buckets to these strategies also needs to be examined more closely by the investment team, Mr. Virtue said.
“We would need to determine at what level of public equity or cash it reduces the benefit of having private equity,” Mr. Virtue said.
Overall, retirement plans are better off with “a different mix of risk exposures,” Mr. Virtue said. “If plan sponsors also have (an open) DB plan and have a different idea of risk and return for their DB plan, it is their responsibility to consider it for the DC plan, if administratively feasible,” he said.
The Washington State Investment Board, Olympia, is one retirement system looking at potentially adding illiquid investments to its $3.8 billion deferred compensation plan and the $2 billion custom target-date funds of its hybrid DB/DC plan.
The board's total allocation portfolio, an option in its hybrid plan, already includes a roughly 43% allocation to illiquid assets — 23% in private equity, 15% in direct real estate and 5% tangible assets (agriculture, timber and infrastructure). The rest is filled out by fixed income (20%) and public equities (38%).
The investment board in “no way” wanted to offer daily liquidity with that combination of asset types, said Theresa Whitmarsh, executive director of the state investment board.
The $7.5 billion total allocation portfolio is commingled with assets of the state's defined benefit plans and is valued monthly. The hope is to include everything that the total allocation portfolio invests in the hybrid plan's target-date funds and in the 457 plan, Ms. Whitmarsh said.
It is still being discussed whether the total allocation portfolio would be offered as a stand-alone option in the 457 plan or a core holding in the 457 plan's $1.7 billion target-date series.
Overall, private markets exposure provides great diversification benefits and the potential for better long-term returns than the typical balanced fund with only public markets assets, Ms. Witmarsh said.
For instance, for the one, three, five, 10 and 20 years ended Dec. 31, the board's private equity program returned 10%, 10.95%, 13.05%, 8.97% and 11.62%, respectively, compared to the board's public equity returns of 9.23%, 3.98%, 10.26%, 4.05%, and 6.57%, in each of those periods.
The investment board considers it “a very prudent option to provide private equity, real estate and tangibles,” she said.