The Defined Contribution Institutional Investment Association (DCIIA) believes that plan sponsors should consider the use of “alternative” investment structures that provide better risk balance in an attempt to reduce the volatility experienced by the typical plan participant.
A newly released DCIIA paper, “Is It Time to Diversify DC Risk with Alternative Investments?” explores the potential for greater inclusion of alternative investments in DC plans.
Lew Minsky (pictured), DCIIA’s executive director, says: “DCIIA’s interest in exploring this topic stems from the potential diversification and performance benefits offered by non-traditional asset classes and alternative strategies to a participant’s asset allocation.”
In the early days of participant directed investments in defined contribution (DC) plans, investment menus were limited largely to guaranteed investment contracts, large cap equity funds, balanced funds and company stock. During the bull-market years of the 1990s, menus expanded to include equity funds of all shapes and sizes, multiple fixed income funds, and self- directed brokerage accounts. Finally, the Pension Protection Act of 2006 ushered in a new generation of managed solutions, such as target-date funds and investment advice tools.
Yet, despite a variety of changes, and, in some cases, improvements in the DC investment architecture, the volatility of the past decade suggests that a critical vulnerability remains: many participants’ portfolios are ineffectively diversified and dominated by equity risk.
In “Is It Time to Diversify with Alternative Investments?”, DCIIA encourages plan sponsors to consider an investment structure that provides better risk balance in an attempt to reduce the volatility experienced by the typical plan participant. One solution to this challenge is to provide access to an asset category broadly referred to as “alternatives”.
The potential benefits of incorporating a well-executed alternative strategy include: potential for improved total-return performance; reduced reliance on traditional equities and bonds; incremental portfolio diversification; lower portfolio volatility; increased consistency of returns.
Minsky says: “While the diversification and performance benefits offered by non-traditional asset classes and alternative strategies to a participant’s asset allocation are clear, the team working on the paper believes that the best way to incorporate these types of investments into a DC plan is through either an asset allocation solution, such as a target date fund, or through a bundled alternative-assets portfolio. In doing so, we believe plan sponsors can meet their fiduciary duty to provide better potential outcomes for their plan participants.”