Time to Diversity Defined Contribution Risks with Alternatives?

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A newly released Defined Contribution Institutional Investment Association (DCIIA) paper, “Is It Time to Diversify DC Risk with Alternative Investments?” explores the potential for greater inclusion of alternative investments in Defined Contribution plans. The paper considers three alternative strategies:

  • Absolute Return and Total Return
  • Private Equity
  • Real Estate

For years, Defined Benefit (DB) plans have allocated to alternative asset classes, while Defined Contribution (DC) plans have not. These allocations have contributed to DB plans’ overall performance outcomes. DC plan sponsors could incorporate alternative investment strategies and best practices used by DB plans, potentially helping to close the performance gap that has long existed between the two plan types.

Furthermore, the volatility of the past decade suggests that there remains a critical vulnerability for DC plan participants: Many participants’ portfolios are ineffectively diversified and dominated by public equity risk.

Non-traditional asset classes and alternative strategies have the potential to offer diversification and performance benefits to a participant’s asset allocation. More specifically, the potential benefits include:

  • potential for improved total-return performance
  • reduced reliance on traditional equities and bonds
  • incremental portfolio diversification
  • lower portfolio volatility
  • increased consistency of returns.

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 that drafted 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, they believe plan sponsors can meet their fiduciary duty to provide better potential outcomes for their plan participants.