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STRATA’s Patrick Hagen Featured: “Bringing Alternative Assets Into 401(k) Plans”

Article originally published in PlanAdviser by Lee Barney – 

While the stock market has recovered since its sharp 30% downturn in March at the onset of the coronavirus pandemic in the U.S., plan sponsors are increasingly interested in helping their participants diversify their portfolios with alternative asset classes, retirement plan industry experts say.

According to TIAA, more than 45% of retirement plan participants have an inappropriate amount of risk in their portfolios. Since 75% of the flows into retirement plans with automatic enrollment go to the qualified default investment alternative (QDIA), it stands to reason that sponsors might consider selecting a target-date fund (TDF), custom TDF or managed account that allocates a portion of the investments to alternatives, says Tim Walsh, senior directing manager at TIAA. “With 75% of the flows going into the default, it would make sense for advisers to try to differentiate their service with QDIAs that invest a small portion in alternatives, including products with guarantees.

“Advisers seem to be preparing for a low-rate environment extending at least through the middle of this decade, so the search for yield is on and they are looking to go out on the yield curve,” Walsh continues. That is why TDFs, custom TDFs or managed accounts that include dividend-paying equities, private equity-type solutions, direct real estate, real estate investment trusts (REITs), commodities and fixed annuities that pass the risk onto an insurance company might make more sense to sponsors and advisers right now, he says. “We are seeing some of these types of alternatives being included in an easy-to-use, packaged solution that is QDIA-compliant,” Walsh says, and when a plan does make these allocations part of its QDIA, it often conducts a re-enrollment to get its participants into this new option.

Tara Fung, chief revenue officer at AltoIRA, a self-directed custodian, notes that, earlier this year, the Department of Labor (DOL) gave guidance on including private equity investments in rettirement plans. For plan sponsors and advisers looking to offer alternatives to participants, Fung says a conservative approach would be to select a “TDF that invests a small portion of its assets in a sleeve that includes private equity and real estate.”

Another approach would be to offer participants a self-directed brokerage window to allow them to select from a wide variety of investments, but the success of that would be contingent on the participants’ investment knowledge, which is why brokerage windows in retirement plans are not common, Fung says.

For its part, TIAA offers RetirePlus, predefined models that are QDIA-eligible. They use the investment options from a plan’s investment menu and reallocate the investments to become more conservative each year as a participant draws nearer to retirement. Fixed and variable annuities can be included in the models.

Ryan Johnson, director of portfolio management and research at Buckingham Advisors, says his firm recommends including on retirement plan investment menus mutual funds or separately managed accounts that invest a portion of their assets in options strategies, convertible bonds and/or merger arbitrage. “Put together, these strategies can have some of the same characteristics as bonds by generating modest income, having a low correlation to stocks and having low overall volatility,” Johnson says. “Alternatives should be a small piece of a diversified portfolio that complements more traditional equity and fixed-income options. Hiring an experienced, specialized mutual fund manager makes sense in these niche areas.”

Johnson says the take-up date of alternative offerings varies among plans, and that “they are more likely found in larger plans with experienced plan sponsors.”

Patrick Hagen, national director at STRATA Trust, also says bringing more diversification into 401(k)s and other retirement plans could greatly benefit participants. Diversification reduces the exposure to any particular asset class. If investments are spread between different asset classes, including those that do not move with the public equity markets, the likelihood of a complete drop in value is reduced—and, yet, very few advisers put their clients into alternative investments.

Tags: 401k, alternative investments, IRA