Providers add alternative investments to target date funds

Some providers of target date options in defined-contribution plans are adding alternative investments ranging from commodities and Treasury inflation-protected securities to real estate investment trusts and master limited partnerships.

Among 20 target date fund groups analyzed in detail by Morningstar Inc., five have launched or announced alternatives options since March: AllianceBernstein LP, ING Groep NV, OppenheimerFunds Inc., The Principal Financial Group and T. Rowe Price Group Inc.

Executives at these firms said that the best way for DC plan participants to invest in non-traditional asset classes is through target date options that contain some allocation to alternatives, rather than in stand-alone options.

Providers are bolstering their target date lineups because “target date funds are primarily aimed at investors who are not self-directed,” said Joshua Charlson, a senior fund analyst at Morningstar.

“Investors tend to chase performance in specialized asset classes,” he said. “Sponsors are more comfortable with a bit of exposure to alternatives in a target date plan.”

For DC plan executives, target date strategies allow the inclusion of alternative assets without some administrative headaches, said David Wray, president of the Profit Sharing/401k Council of America.

Because target date funds are managed by professionals, “you don’t need the same level of explanation to participants [as with stand-alone funds],” he said.

A recent PSCA survey of 931 DC plans showed that about one-third have stand-alone REIT funds, and about one-fourth have other stand-alone sector funds, Mr. Wray said.

“You find [alternative assets] in customized [target date] funds for large plans, but you are beginning to find them in off-the-shelf” target date funds, he said.

The latest additions by providers exclude investments such as private-equity and hedge funds, as well as direct investments in real estate. In some cases, alternatives are offered exclusively in the respective companies’ target date families and aren’t available as stand-alone options.

“You don’t want the participant to chase the return of a volatile stand-alone alternative investment,” said Matthew Gnabasik, managing director of consultant Blue Prairie Group LLC.

SMOOTHING THE RIDE

“Given the market volatility since 2008, sponsors are demanding solutions that will smooth the ride for participants,” said Ross A. Bremen, a partner at NEPC LLC. He thinks that alternatives are better-suited for inclusion in target date funds than as stand-alone funds.

Although NEPC has several clients that offer stand-alone options, “a lot of big plans are looking to include alternatives as part of their custom target date strategies,” Mr. Bremen said.

Packaging several alternatives into one option can be more attractive as investment strategies move in and out of favor.

For example, “some people are becoming less enamored with REITs because they’re seeing higher correlations between REITs and equities,” Mr. Charlson said.

“If you want an inflation hedge, TIPS alone might not be sufficient,” said Chris Lyon, a partner at Rocaton Investment Advisors LLC. “You need more than one tool in the tool kit.”

One example of a packaged deal is coming from AllianceBernstein. Starting Dec. 31, the Global Real Estate Investment Portfolio will become the Real Asset Portfolio, and the investments will change from REITs alone to a mix of REITs, commodities, TIPS and commodities-related securities.

Based on internal research, the company concluded that the four asset classes would be better than one as a “diversifier,” said Thomas J. Fontaine, head of DC investments at AllianceBernstein.

“It should provide comparable returns to REITs, but with less volatility,” he said. “It offers enhanced inflation protection.”

The new portfolio, like the old one, will be included in each of AllianceBernstein’s 12 target date funds and will be available as a stand-alone option as well. The firm’s target date portfolios also include high-yield bonds and TIPS.

Executives investigated incorporating equity real estate, private-equity and hedge funds in its target date lineup but decided against it, partly due to the relative illiquidity and higher costs, Mr. Fontaine said. Another impediment was sponsors’ concerns about the complexity and lack of transparency of hedge funds.

AllianceBernstein has $17.3 billion in target date assets.

T. Rowe offers some funds — such as emerging-markets equity and high-yield-bond funds — as components of its target date portfolios or as stand-alone investments.

But company officials think that alternative investments aren’t appropriate as separate options for most retirement investors.

“They belong in a diversified-allocation product more than in stand-alone products,” said vice president Pegi Almond.

“Participants don’t understand these assets,” she said. “They buy high and sell low.”

Since July, T. Rowe has added two funds to its target date offerings: The Real Assets Fund invests in commodities-related stocks; the Inflation-Focused Bond Fund re-placed the Short-Term Income Fund, which invested in cash and short-term fixed income.

The co-managers of the Inflation-Focused Bond Fund have the flexibility to adjust their TIPS allocation to as low as 20% or as high as 100%. Cash and short-term fixed-income instruments can be added as the market warrants, said Wyatt Lee, investment analyst with T. Rowe Price’s asset allocation group.

The Real Assets Fund, an inflation-protection strategy, invests primarily in metals, mining, natural-resources and REIT stocks. Again, the portfolio manager has the “flexibility to underweight or overweight [different sectors] within the fund,” Mr. Lee said.

“We thought of packaging all of this into one inflation product, but we decided to separate the fixed-income-based and equity-based products,” he said.

T. Rowe Price officials reviewed the company’s asset allocation strategy because “we didn’t think we could [improve performance] with traditional-type assets,” Mr. Lee said.

T. Rowe Price has $45.9 billion in target date fund assets.

Although The Principal had been offering REITs and TIPS as stand-alone options for about six years, company executives in March created an inflation-protection fund to diversify the traditional stock and bond mix of its target date portfolios, said Randy Welch, director of investment services.

The Principal Diversified Real Asset Fund invests in REITs, TIPS, commodities, natural resources and master limited partnerships. Each component has a separate subadviser.

“We strongly believe that target date funds are a great investment vehicle for retirement investors,” Mr. Welch said.

“Most retirement plans don’t expose participants to [alternative] asset classes as stand-alones. Sponsors don’t want it; advisers tend not to go for it,” Mr. Welch said.

The Principal has $14.5 billion in target date portfolios.

Following a trial run as a tactical asset, commodities were added to ING’s target date lineup in May.

“After extensive research, we concluded that it merited a strategic weighting due to its diversification and good defense against declines in the dollar over time,” said Paul Zemsky, head of multiasset strategies and solutions for ING Investment Management.

The commodities portfolio is available only to ING’s target date investors, as are TIPS and high-yield bonds. ING also offers global bonds and senior-bank-loan securities for target date portfolios and as stand-alone options.

ING has REITS as a target date component and a stand-alone option, but “we don’t recommend [that] sponsors offer volatile asset classes like REITS and commodities,” said Seth Finkelstein, portfolio manager for multiasset strategies and solutions. “We’re concerned that participants would chase returns, and enter and exit these asset classes at the wrong time.”

ING has $5 billion in assets in target date funds.

OppenheimerFunds overhauled its $400 million target date portfolio, shifting in July from offering only commodities to a package of commodities, TIPS, REITs and gold. All but TIPS also are offered as stand-alone options.

The composition can be adjusted based on the portfolio manager’s evaluation of market trends, said portfolio manager Alan Gilston. “Inflation is an issue for our investors, but inflation is self-correcting and is relatively short-lived,” he said,

OppenheimerFunds changed its inflation hedge strategy when it changed its target date alternative portfolio. Commodities had ac-counted for a 5% allocation in each of seven target date funds stretching from 2010 to 2050.

The present allocation for the basket of alternatives is 10% for the 2010 and 2015 funds, 5% for the 2020 fund and zero for the longer-dated funds.

“Where investors have 10 years or less to retirement, short-term inflation can be critical,” Mr. Gilston said. “We invest aggressively when time is an asset and conservatively when time is a liability.”

Robert Steyer is a staff reporter with sister publication Pensions & Investments.