Defined contribution plan investments could become a bit more exotic, if Goldman Sachs’ Kurt Winkelmann has anything to say about it.
Mr. Winkelmann, managing director and head of global investment strategies at Goldman Sachs Asset Management, New York, sees the use of "exotic beta" strategies in target-date funds as the natural evolution of DC into more advanced strategies that once were the domain of defined benefit plans.
In a recent interview, Mr. Winkelmann said he sees portfolio diversification as a key element of DC investing — and the use of these new investment strategies as a means of obtaining that diversification in several ways.
“The target maturity fund (target-date fund) is a way of addressing the benchmark issues and portfolio diversification issues,” he said.
Increasingly, target-date funds, for example, will not just look at diversification as an equity-bond split but will also bring in investments in different smaller subclasses such as small-cap stocks, international equities or emerging markets equities — Mr. Winkelmann’s definition of exotic beta.
Exotic beta differs from alpha, Mr. Winkelmann said. While alpha requires a manager to add something extra to a portfolio through active investment, exotic beta means being passively invested, either overweight or underweight a particular asset class. On the fixed-income side, exotic beta can come from other credit instruments such as global property securities and commodities futures as well as investment grade credit.
AllianceBernstein includes global REITs in some of its target date funds, but not commodities, according to Tom Fontaine, head of investment research and design at AllianceBernstein’s Defined Contribution Group in New York.
Phil Suess, worldwide partner at Mercer Investments, New York, said he has heard of target date funds moving toward more sophisticated products such as commodities futures and global REITS, but only on a limited basis.
“In my view, investors can approach this piece of the puzzle (diversification) by looking for asset classes that are chronically mispriced relative to capital market equilibrium,” said Mr. Winkelmann, “Each of these sources of exotic beta can provide two potential benefits for investors. First, they can enhance portfolio returns, since these asset classes have typically been mispriced relative to a capitalization weighted portfolio. Second, portfolios with these asset classes can reduce their risk, again, relative to a capitalization weighted portfolio.”
Thus, over extended periods of time, investors with exposure to these asset classes should expect to see more diversification and above-average returns.
The use of alternatives can also play a partin a target date strategy, as Mr. Winkelmann said DC plans in Australia have been doing on a small scale. However, he noted some issues such as liquidity risk have yet to be solved given the exotic, and often illiquid, nature of some of the investments.
DC investors have limited investment time horizons and face liquidity risks in their portfolios and investment and cannot hold assets until maturity, unlike their DB counterparts, Mr. Winklemann said.
DC investors do not live forever, "and in the long run will face liquidity risk, as are DB (defined benefit) investors,” said Mr. Winkelmann.
One thing that can alter or increase investment opportunities is investor education to help investors to better gauge their retirement income needs. To date, most investment focus has been centered on accumulating retirement savings, but Mr. Winkelmann said that focus should be changed to the distribution phase — how much will be needed for a secure retirement.
“Fundamentally it’s all part of one process and we’ve made this artificial split of accumulation and distribution,” Mr. Winkelmann said. “The entire lifecycle should be looked as a whole, rather than splitting it into two phases.”
Current advice is focused on what the investment portfolio looks like, rather than on the purposes the portfolio will serve. The focus appears to center on investors’ attitude towards risk, rather than how investors plan to use saved retirement assets.
Future retirement education should focus more on expected retirement income needs, in particular keying on how much a retiree might trade off in terms of retirement goals, and less on expected rates of return on investments. The focus on retirement needs increases with the shift toward DC plan usage, he said, adding that he sees the need for early education expanding to workers who are in their 20s, not just those in their 30s or 40s.
“We need to develop and use a better framework of questions to establish what retirement cash needs are and find out what a participant is willing to do or forgo for retirement,” said Mr. Winkelmann.