Mr. Minsky believes other large plan sponsors are increasingly thinking about the way they designed the investment structure of their defined benefit plans “and naturally thinking, why would we design (the) glidepath and investment structure of target-date funds differently than we do (our) DB investment structure?”
The New Mexico Public Employees Retirement Association's Smart Save Deferred Compensation Plan is currently searching for its first private real estate manager, hoping that will reduce volatility of real estate investment trusts now held in its custom target-date funds, said Karyn Lujan, Santa Fe-based deferred compensation plan manager.
Each of the $553 million plan's nine target-date funds has an 8% to 12% allocation to global real estate investment trust manager Invesco Ltd. The private core real estate manager would replace Invesco in the target-date fund, while Invesco would continue to manage a stand-alone global REIT option in the plan's core lineup.
The selected private real estate strategy must be set up to provide daily valuation, such as in a collective investment trust or insurance company separate account. “Daily liquidity of regular redemptions of up to 10% per quarter” is also required, Ms. Lujan said. A hiring decision could be made as early as May 25. Investment consultant Meketa Investment Group is assisting. Callan's Mr. Venerusopointed to the number of real estate managers launching DC-friendly private real estate strategies and noted the Defined Contribution Real Estate Council's efforts promoting the asset class and presenting a unified front on liquidity and implementation as reasons for private real estate's pickup over other illiquid investments.
He also cited the public's familiarity with real estate as a potential driving factor.
“I think real estate at a very basic level is easy to understand, so it's an asset class that the general public does have exposure to,” Mr. Veneruso said.
Other consultants pointed to fees and the longer history of direct real estate offerings as reasons for its greater pickup.
If plan executives are moving from actively managed real estate investment trusts to actively managed direct real estate, the fee differential might not be all that significant, said Liana Magner, Boston-based partner and U.S. DC investment leader at Mercer LLC.
To help meet plan executives' daily valuation and liquidity demands, many real estate managers are including allocations to real estate investment trusts, cash and/or credit in their private real estate strategies, consultants said.
PGIM Real Estate offers two private real estate strategies for DC plans with an aggregate of approximately $1.4 billion in assets under management.
Both offerings are fund of funds that invest in PGIM's open-end private real estate strategies and REITs. They are structured as insurance company separate accounts.
The flagship strategy, launched in 2006, has a core-plus profile and includes a roughly 25% allocation to REITs.
The second strategy, launched in 2015, has more of a core profile and a roughly 15% allocation to REITs. A daily valuation is calculated by “allocating pro-rata shares of projected income and appreciation of the underlying direct real estate fund(s) and then combining with REIT pricing. The income/appreciation projections are adjusted as needed to reflect macroeconomic events, major transactions, property specific events, etc.,” said David Skinner, executive director, defined contribution practice leader at PGIM Real Estate, Madison, N.J.
Mr. Skinner said the strategies are primarily being included as sleeves in multiasset-class strategies, including target-date funds, and that the second strategy is garnering more interest because of its lower REIT exposure. Some $950 million is invested in the flagship strategy and $450 million is invested in the second strategy.
Prudential's Day One Funds target-date series includes a roughly 5% allocation to the flagship strategy.
Outside of Prudential, one target-date provider includes the flagship strategy in an off-the-shelf series and another includes the second strategy. Mr. Skinner declined to name the two target-date providers.
“There is an amount of concern about future returns in equity and bond markets. I think plan sponsors as well as the target-date community are starting to say we need to expand the way we are(thinking) about asset allocation. Those practitioners are looking at other asset classes that can help returns or protect the downside even more. That's one trend that bodes extremely well for private real estate,” Mr. Skinner said.
Mr. Skinner believes fees remains a hurdle for DC illiquids and that valuation and liquidity concerns have come down.
If one of the proprietary target-date funds invests in private real estate, it's a “signal to the rest of the marketplace that it's a core asset class DC plans are investing in and could reduce some of the litigation risk concern,” he argued.
PGIM Real Estate is a member of the Defined Contribution Real Estate Council.
The first mutual fund target-date series to provide direct real estate exposure is Nuveen's Lifecycle Funds. The direct real estate allocation, now 1%, is expected to be boosted to 5% and is managed by TH Real Estate via a private fund.
Having an allocation to direct real estate in a target-date fund “provides enhanced diversification, reduces volatility and improves long-term investment outcomes,” said John Cunniff, New York-based managing director and portfolio manager at TIAA.
Noting that the majority of target-date assets today are held in mutual funds, Erin Donnelly, New-York based executive vice president and head of defined contribution investment only at Nuveen, TIAA's asset management unit, said that the firm is able to target a broader segment of the investor and plan sponsor universe by incorporating direct real estate into a mutual fund target-date series.
The Securities and Exchange Commission has a 15% limit on illiquid investments in mutual funds, which Callan's Mr. Veneruso said has been a “big hurdle” for the '40 Act space.
Similar to the real estate managers, Partners Group Ag and Pantheon Ventures LLC include allocations to liquid assets in their DC private equity strategies, which launched in 2015. However, both firms are still waiting on their first U.S. DC clients.
“I think it's important to outline the pros and cons” of adding illiquid investments to DC plans, said Mr. Veneruso. “There are definite advantages there. It's up to plan sponsors to weigh whether those advantages outweigh the fees and added operational complexity.”
David O'Meara, New York-based senior investment consultant at Willis Towers Watson PLC, said the firm “strongly encourages” DC plan executives to evaluate adding illiquid investments, although “it's not necessarily something that we are pushing in the marketplace.”
“Plan sponsors need to be aware of (their options), especially as DC plans grow and get to be a larger part of the retirement puzzle,” Mr. O'Meara added. “If there is a way to get better outcomes for participants, it deserves a hard look, regardless of the complexity involved.”
Christopher Lyon, Norwalk, Conn.-based partner and head of defined contribution at Rocaton Investment Advisors LLC, added: “We believe in providing participants with broadly diversified strategies in their default option and their ability to build broadly diversified portfolios through their core menu. Considering alternatives and less-liquid strategies is certainly a reasonable consideration. Maybe it's not right for every plan and circumstance, but we are open-minded.”
Regarding some plan executives' concerns on the potential dampening effects of adding liquidity buckets to illiquid strategies, Mr. Lyon said in most cases, plan executives are “starting with pretty liquid target-date funds already.”
The real question is “Does this move the needle? ... Does illiquidity add something as opposed to taking away from it?” he said.