Making the case for alternative investments in a long-term, properly allocated portfolio is easy. Finding a company-sponsored retirement plan that offers ready access to anything but traditional, long-only stock and bond funds is nearly impossible.
If participants in today's defined-contribution plans are going to have any chance of building a respectable retirement nest egg, that's got to change.
“We're really stuck in the Stone Age on this particular issue,” said Nadia Papagiannis, an alternative-investments strategist at Morningstar Inc.
“Plan sponsor boards don't always understand alternative strategies and don't want to have to explain why they let employees invest in a fund that could blow up. They think anything that is not long-only is risky, which is a common misconception,” she said.
So few are the alternative-strategy mutual funds in employer-sponsored retirement plans that the number is not even measurable, according to David Wray, president of the Profit Sharing/401(k) Council of America.
“The [company-sponsored-plan] system by its nature is pretty generic,” he said. “And it's an immensely passive system, and that's with a small P.”
Companies willing to entertain offering “out-of-the-mainstream products” sometimes will give employees the option of accessing alternatives through a portal to a separate brokerage account, Mr. Wray said.
About 13% of company-sponsored retirement plans include the brokerage option, he said.
Some alternative strategies, such as long-short equity, market-neutral and absolute return, are also finding their way into company-sponsored plans through target date funds. Target date strategies, which delegate the fund selection process to a plan provider that is typically a fund company, represent the most common use of alternative strategies in company-sponsored plans.
But that still doesn't resolve the issue of how investors outside of target date funds are expected to navigate market volatility with funds designed for only one direction.
“If they're in a 401(k) plan that only offers long-only funds, investors are condemned not to do well,” said Gabriel Burstein, global head of investment research at Lipper Inc.
Mr. Burstein is so passionate about this topic that he wants to see a new regulation that requires plan sponsors to offer more alternative strategies, and possibly even require minimum allocations to alternatives.
“You can still invest in long-only funds, but investors need to add a piece that is designed to be independent of the market's direction,” he said. “A portfolio should have a minimum of 20% to 30% allocated to something that does not bet on the market's direction.”
The appeal of many alternative strategies is an ability to dampen overall portfolio volatility, which becomes increasingly important as investors get closer to retirement.
“Alternatives can help investors deal with the sequence of returns,” said Robert Reynolds, chief executive of Putnam Investments. “If your portfolio suffers some bad returns in later years, you have less chance of recovering.”
In December 2008, Putnam launched an absolute-return family of mutual funds designed specifically for retirement portfolios. The funds, which aim to provide returns above the rate of inflation by 1, 3, 5 and 7 percentage points, already have attracted $3.3 billion.
But most of that money has come in through financial advisers working directly with clients, and not through company-sponsored retirement plans. Some progress is being made on that front: the Putnam Absolute Return 500 Fund Ticker:(PJMDX), which targets a 5-percentage-point return over inflation, recently was qualified by Dalbar Inc. as a default option for 401(k) plans.
Keep in mind that this Putnam fund, like the others in the series, will allocate to currencies, commodities and derivatives, and can even go short. To see such a strategy deemed qualified as a conservative default option when an employee doesn't designate an investment choice is a long way from the days of defaulting to money market funds.
Of course, it will still take a lot more pressure from the industry, financial advisers and perhaps employees themselves to persuade plan sponsors to add alternative strategies to their menu of investment options.
Questions, observations, stock tips? E-mail Jeff Benjamin at [email protected].
