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Defined Contribution

University of California considering adding alts to its target-date funds

University of California defined contribution program officials are considering adding alternative investments to its target-date funds as part of possible changes the $23.8 billion program could make by 2020.

Plan participants in the University of California's program and across the U.S. are dealing with the "disappearance of guaranteed income," said Marco Merz, director of defined contribution, at a investments subcommittee meeting on Tuesday.

With equity and fixed-income returns expected to be lower than in the past, he suggested unitizing the "higher returning" private equity and real estate portfolios in the University of California's $66.6 billion defined benefit plan and $11.5 billion endowment, and adding them to the target-date funds, which have $8.8 billion in assets.

In addition, in order to encourage participants to save more, Mr. Merz also said the program could entertain adding an auto-escalation feature. Program officials may also add to the defined contribution program an embedded guaranteed income feature that would act like an annuity. This feature would act like a fixed-income investment and then when the participant is 65 years old, it would be annuitized. The UC would "hand over the fiduciary risk" by hiring a third-party firm that would choose the annuity to be purchased, Mr. Merz said.

The program could also add to the target-date funds a fintech solution that would allow participants to exclude investments in order to incorporate environmental, social and governance factors.

"We have transformed asset allocation and longevity risk from the employer to the employee," Mr. Merz said. "That's why the target-date funds are so important. There is a possibility of running out of money for employees without access to a defined benefit plan."

Separately, the board of regents at its meeting Thursday lowered the employer contribution by a percentage point to 14%. The board had increased the employer contribution by a percentage point last year.

The board rescinded the employer contribution increase because it expects a $30 million shortfall in funding from the state. "Given the alternatives — not investing in student resources, worsening the faculty salary gap, etc. — rescinding the planned increase in the university's employer contribution is a prudent strategy," a report to the board states. The report also noted the pension plan's "strong investment performance that was not yet known when the increase to 15% was proposed," the report states.

Lt. Gov. Gavin Newsome, who is a member of the board of regents, said that reducing the employer contribution rate to the pension plan "is how we got into trouble in the past."

"It is potentially problematic to rescind a wise choice made in July" when the board boosted the employer contribution to 15%, he said.