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The opportunity in defined contributions

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As the industry watches the growth of liquid alternatives among institutional and individual investors, fund managers are also looking ahead. The retirement market may be the next frontier. It represents a large and growing pool of assets driven by the importance of retirement savings across multiple investment segments.

How is growth in the retirement space opening the door to liquid alternative strategies? This Q&A with Pershing's subject matter experts Mark Aldoroty (pictured) and Rob Cirrotti will help fund managers understand what to consider when looking to the defined contribution (DC) plan space as a growth opportunity. There continues to be a structural shift in the marketplace from defined benefit (DB) to defined contribution (DC) plans. In fact, DC plans have become the central structure for retirement savings in the US. 

If you look at an IRA as a traditional wealth management solution with access to all kinds of investments, you can understand why people often move money to an IRA. They want and need to access those advisers and more flexible investment options. Alternatives have become an important part of those strategies as investors look for new ways to hedge risk. Exposure to these strategies outside of DC plans has led us to question why we cannot have those kinds of vehicles in DC plans.

How can liquid alternatives fit into a DC plan?

One way for alternative investments to permeate the DC space is through the independent advisers and RIAs that act in a fiduciary capacity. These advisers often create their own advisory models. So when alternatives are included in these turnkey investment portfolios or packaged investment advice, you inherently give plan participants the right structure to utilise alternatives. As we figure out how to embed these advice solutions we usher in the opportunity to access liquid alternatives.

Increasingly, plan advisers are focused on new strategies to improve plan participant outcomes. They understand how liquid alternatives can carry through to the plan participants and help mitigate risk while still capturing upside. But before plan advisers can feel comfortable recommending liquid alternatives to their clients, they need to feel that alternative managers are launching funds built on strategies that are transferable and will translate well into liquid form. Those funds with transferable strategies can now find a place in the growing segment.

What is an attractive DC plan-focused alternative offering?

There are two elements that should be considered to make an alternative offering attractive to a DC plan. First, plan advisers need to examine what reasonably converts from the hedge fund space to the DC plan space. The strategy needs to feel like a daily liquid product, and not everything will prove to be transferable. Second, the DC plan space itself wants to know how to get greater access to hedge funds. DC platforms are evolving to accommodate less frequent liquidity events, so as hedge funds begin to understand what products work within the space, alignment will increase, driving more liquid alternatives into DC plans.

The challenge is to position liquid alternatives within these embedded advice solutions. One avenue to consider is packaged target date funds. By gaining access to the fund's decision-makers, whether they are the portfolio managers or CIOs, alternatives managers can position themselves well within the larger DC plan strategy.

What are the common reservations when first considering including alternative strategies? How can they be addressed?

Ultimately, the performance of a DC plan is dependent upon the fiduciary. As the fiduciary becomes more comfortable with alternatives, the trend to include these vehicles in a plan's investment options will continue to grow. From a DC plan adviser's standpoint, engendering that level of comfort is the biggest challenge. The DC plan advisor understands the value of these investments, but the fiduciary, the one who is truly responsible for the plan, has the biggest hurdle. The fiduciary must make decisions for the plan that are prudent. First they need to understand and educate themselves on the investment. Then balance the benefits of these new alternative investment vehicles with the liability and risk of incorporating them in the plan participants' investment options.

Two facts that should not be ignored: DC plans offer ingredients for a successful outcome and plan participants can use all the help they can get. So, if an alternative strategy can help plan participants see greater returns with no significant additional risk, then from an investment policy perspective it becomes a strategy worth considering.

The bottom line should be whether liquid alternative funds can help produce greater returns without increasing an individual's risk. If liquid alternative funds can get plan participants on a path to a more secure retirement, then they have a role in the DC plan.

What message do DC plan advisers need to communicate to DC plan fiduciaries?

Liquid alternatives can play an important role in a retirement plan. Fiduciaries need to understand the benefits to their plan participants and their portfolios. Increased returns or hedges that reduce risk can increase returns which can have a significant impact over time. But experience and comfort go hand in hand. These liquid alternative strategies might be completely new and unfamiliar to fiduciaries. We have seen the evolution of new products before. Mutual funds are household names now; eventually the same thing will happen with alternatives and hedging strategies. As these strategies become more pervasive, fiduciaries will understand them better. When fiduciaries are more familiar with them, they will welcome alternatives into their plan lineups.

What are the most critical evaluations for DC plans to make when they are considering including alternative investments?

One could argue that fiduciaries have an obligation not only to avoid risk but to actively seek increasing returns. A fiduciary should not focus solely on how to demonstrate a prudent selection process. He or she needs to think about how to carry plan participants to an adequate retirement. A more progressive fiduciary wants to know where to look for investments that will deliver the best returns, while being mindful of the investment risk involved, and help participants grow their investments to the levels they need for a secure retirement. That shift in the marketplace is an opportunity that plan advisers can seize. 

More plans are bringing in specific, professional investment fiduciaries. These fiduciaries do look to alternative vehicles, and they want to be innovative around the way they are being evaluated. These fiduciaries are still judged on the process and thoughtfulness of the investments they recommend, but are increasingly being judged on plan participant outcomes. If a plan adviser cannot show value with greater outcomes, the questions about the success of the DC system will continue to be raised.

What are the next steps for advisers, liquid alternative managers and DC plan fiduciaries?

Education around liquid alternatives must continue for RIAs and the investment professionals within the industry who are holding themselves out to be 401k or DC plan specialists. Liquid alternative managers should also provide education and resources for DC plan fiduciaries so the fiduciary is best equipped to make decisions about the prudence of the alternative fund in the DC plan. A plan fiduciary may even look to the alternative fund manager to help share investment liability. 

While the role of a DC plan fiduciary remains the same, in providing prudent investment decisions, the investments to consider are ever changing. With the growth of alternative investments, DC plan fiduciaries need to educate themselves on new products and how they will, or will not, fit into their DC plan investment menu. By consistently evaluating new investment vehicles and asset allocations for suitability within a DC plan, plan participants will be well positioned to have adequate retirement savings through a combination of investment options fit to their needs and retirement savings goals. 

About the experts:

Mark Aldoroty has had a prime brokerage career spanning more than 25 years. Currently, Mark is a managing director for Pershing, a BNY Mellon company. He is a member of Pershing Prime Services Management Committee and leads the Prime Services Sales and Relationship Management teams. 

Rob Cirrotti is a managing director for Pershing, a BNY Mellon company, where he leads Retirement Solutions. Rob oversees the strategy and development of retirement and insured solutions to help clients grow retirement assets. Rob is a board member of the SPARK Institute, and a member of the SIFMA Retirement Committee, American Society of Pension Professionals & Actuaries, Insured Retirement Institute and the Money Management Institute Retirement Committees.

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