Defined contribution plan consultants are supporting further diversification into alternatives such as real assets to protect against inflation as well as reduce volatility.
According to a survey of executives at 49 consulting firms to be released by Pacific Investment Management Co. LLC on April 14, adding commodities, TIPS and REITs are very important or important in creating an inflation-protected or real asset option.
“We have been encouraging our clients to add real assets into DC plans with the acknowledgment that real assets are more important in a DC plan than in a DB plan,” said Stacy Schaus, executive vice president and defined contribution practice leader of Newport Beach, Calif.-based PIMCO, in a telephone interview.
The reason inflation protection is more important for DC plans, Ms. Schaus said, is because “typically DB plans are paid out nominally so they don't have the risk of failing to keep pace with the cost of living.”
When adding an inflation-protected or real asset option, a total of 93% of the consultants surveyed believe commodities are important or very important, with 83% saying Treasury inflation-protected securities and 66% citing real estate investment trusts.
The emphasis on inflation protection is part of a larger trend of consultants' focus on risk replacing the traditional “style-box” approach to investment lineups.
“We believe it makes a lot of sense when we look at the traditional DC lineup — very often style-box-driven — where it's historically filling the equity style, making sure you have large cap, small cap, value, growth,” Ms. Schaus said. “The issue with that is you still have one type of risk, which is equity risk. Increasingly, people are not looking at the asset classes, but the underlying drivers of risk.”
Alternatives particularly have the support of consultants when it comes to designing custom target-date strategies, with 98% strongly supporting or supporting the use of alternatives in those strategies. About 63% of consultants believe the same about multimanager/ white label core options and 51% strongly support or support alternatives as a single manager, multistrategy core option.
While one might think higher returns would be the reason for embracing alternatives, it turns out consultants still have risk in mind.
“A surprising percentage for support that came through in the study is that the drivers of interest in these diversified assets overall are primarily risk reasons,” Ms. Schaus said. “There's the opportunity to reduce volatility by adding diversified assets, including alternatives.”
Ms. Schaus said 93% of consultants responded they feel alternatives are very important or important in achieving volatility reduction. The next highest responses were return enhancement at 79% and inflation protection at 76%.
Consultants also believe moving DC plans away from daily valuation would ease the plans' ability to offer more alternatives.
“The ability to offer alternatives right now (is limited),” Ms. Schaus said, “Most of the alternatives would need to be daily valuation and daily liquidity, and if you moved DC plans away from daily valuation, you would remove that requirement.”
Of 40 consultants who responded to the question, 53% believe the lure of being able to offer more alternatives would move DC plans away from daily valuation. One-third of respondents believe plans will move from daily valuation in order to “send a message that the DC plan is for retirement.”
“Why are people paying for (daily) liquidity and daily pricing when they don't really need it?” Ms. Schaus asked.
Moving beyond traditional domestic core fixed-income strategies is also on consultants' minds.
When asked which asset classes would add value to a plan as a core fund, 75% of consultants responded global or non-U.S. equities, followed by global or non-U.S. fixed income at 63% and real assets at 60%.
When asked in 2013 about asset classes that would add value, only 43% answered global or non-U.S. fixed income, Ms. Schaus said.
Also, 51% of consultants believe that DC plans are highly likely or likely to add diversified fixed-income offerings such as investment-grade credit or high yield.
The survey of the consulting firms, overseeing a total of $2.8 trillion in assets under advisement, was conducted early this year. n