Target dates take aim

Real estate offers stability, diversification

Dec 16, 2012 @ 12:01 am

By Darla Mercado

Direct real estate investment in target date funds is looking more attractive as a way to mitigate the effects of market volatility on defined-contribution plans, but advisers warn that there is a right and a wrong way to use these tools.

Firms including Prudential Financial Inc., J.P. Morgan Asset Management, UBS Asset Management and Clarion Partners LLC have sought ways to include direct real estate as a component of target date funds.

While UBS, Clarion and Prudential provide real estate as part of a custom target date fund, J.P. Morgan offers it within its SmartRetirement series.

Yet only a sliver of plan assets are in these options. A study by Callan Associates Inc. in the first quarter showed that only 3.3% of target date funds have a stand-alone allocation to private real estate within their glide path.

Callan also offers target date funds, with the direct real estate component managed by Prudential.

“There is a broad agreement that target date funds are dependent on equities for returns, and with the 10-year Treasury at 1.64%, there is certainly downside risk on the capital return for bonds,” said Dave Esrig, director, managing director and head of real assets research at J.P. Morgan. “Real estate offers diversification you can't get from the securities markets.”

Yet advisers warn that bringing real estate to the retirement plan world requires caution.

“It can be good as part of a blend, but it can be subject to abuse if it's added to a menu of free-standing choices,” said Jim Phillips, president of Retirement Resources Investment Corp.

A study from J.P. Morgan to be released soon shows that direct real estate investments blended with real estate investment trusts had negative total returns in 18% of the quarters since 1978.

In comparison, commodities experienced negative total returns in 41% of the quarters going back to that period, while a 60/40 portfolio divided between equities and bonds had negative returns in 25% of the quarters.


Executives at J.P. Morgan are making the case for target date funds to allocate 5% to 10% of their assets in direct real estate, and the firm includes the asset class in its SmartRetirement target date suite through its Diversified Commercial Property Fund.

That fund features a blend of 75% direct real estate and 25% REITs to provide liquidity. “What the [defined-contribution] market requires is a daily fair value and some amount of liquidity,” Mr. Esrig said.

Prudential Real Estate Investors also offers a 75/25 portfolio of direct properties, and securities and cash, making the investment available to plan sponsors and consultants. When used in this context, the allocation of assets to the real estate portfolio is 8% to 10%, according to David Skinner, defined-contribution practice leader at Prudential Real Estate Investors.

One obstacle for plan sponsors is that it can take as long as three months to pull a plan's assets from a real estate holding, depending on the size of the investor — even with the added liquidity from the REITs.

“Not only do they have to set things up with the record keeper, they have to set things up with the participant,” said Leonard Kaplan, U.S. portfolio manager for the opportunistic investing group at PREI.


The real estate market is also subject to downturns that can coincide with tough times for other assets.

“I think in more normal environments, we'll get the expected return and diversification benefits,” said Kelly Cliff, chief investment officer at Callan Associates. “But given the crisis that was centralized in real estate, we didn't see the benefits versus the other approach.”

As a result, advisers embrace it in a controlled environment but eschew it as a stand-alone option for 401(k) participants to invest in on their own.

“We like the idea of considering real estate as a commodity,” said George Fraser, managing director at Retirement Benefits Group, a firm that's affiliated with LPL Financial LLC. “We don't want to make the mistake of putting all the eggs in the real estate basket.” Twitter: @darla_mercado


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