RETIREMENT - Alternative Retirement Plans

Even as the alternatives market swoons, money managers are adding asset classes beyond stocks and bonds to defined contribution plans.

Asset managers in defined contribution plans are starting to include more than just stocks and bonds in their allocations. That’s particularly true of so-called target-date and target-risk portfolios, which are constructed around an investor’s planned retirement date or risk tolerance. Asset classes ranging from global real estate and commodities to Treasury Inflation Protected Securities (TIPS) and alternative investments like market-neutral funds are offered. Some asset managers are even exploring adding hedge funds and private equity.

The moves borrow from the playbooks of corporate and public pension funds, foundations and endowments, all of which have been adding alternative investments to diversify and protect their portfolios. The challenge for plan sponsors is how to communicate the opportunities to participants.

“Explaining commodities, futures contracts or hedge funds is like trying to explain brain surgery in a couple of minutes,” says Joe Ewing, vice president of investor relations and human resources at Terra Industries in Sioux City, Iowa. Asset managers have launched

target-date and target-risk funds since the bear market of the early 2000s to stop investors from chasing funds with the hottest performance and to push them to create diversified portfolios. The funds got a shot in the arm from the Pension Protection Act of 2006, which directs the Department of Labor to define eligible investments that can be used as default options for employees who do not make their own choices. The DoL’s Employee Benefits Security Administration has proposed including target-date and target-risk funds on that list.

Goldman Sachs Asset Management, Principal Financial Group’s Principal Global Investors, AllianceBernstein Institutional Investments and UBS are among the managers exploring ways to add alternative asset classes to these popular retirement funds. GSAM, with $7.6 billion in its asset allocation funds, has launched a specialized fund that uses only so-called exotic beta asset classes, including global commodities, real estate investment trusts, emerging-markets equities and high-yield bonds. The fund is designed to be used with one of its target-risk funds. “Everyone is thinking hard about mixing portfolios differently now,” says Alec Stais, head of the multiproduct investment group.

As 401(k) plans have matured, sponsors have incorporated features of traditional pensions. Michael Finnigan, chief investment officer at Principal Global Investors, which has $24 billion in target-risk and target-date funds, says these offerings are “starting to feel like old defined benefit plans with multiple asset classes and automatic rebalancing between sectors. Private real estate, natural resources and hedge funds are a natural extension of that evolution.” Principal has added asset classes such as preferred securities and TIPS, as well as REITs, high-yield bonds and emerging-markets equities, to some funds. It is looking for a way to include private equity, private real estate and hedge funds to its offerings.

Recent market gyrations could crimp the appetite for alternatives. “Sponsors are discovering that the bond fund in their plan may not be quite as vanilla as they originally thought,” says Carl Hess, a Watson Wyatt Worldwide consultant. But, he adds, “there’s an inevitable move to TIPs, commodities and even hedge fund strategies in target funds.”

DWS Scudder, the U.S. retail division of Deutsche Asset Management, offers a fund of funds that is far along the curve toward hedge funds, say consultants. DWS Alternative Asset Allocation Plus includes a market-neutral fund; it also uses a portable alpha strategy and mixes in commodities, emerging-markets debt and equity, global real estate securities, gold and precious metals, among others. “Sponsors want to improve the diversification choices available to investors, but they don’t want to add just a commodities fund or an emerging-markets fund,” says Doug Beck, head of product management at DWS Scudder. DWS plans to add similar alternatives to its target-risk funds.

Joseph Healy, director of defined contribution product management and marketing for AllianceBernstein Institutional Investments, says plan sponsors are increasingly asking about alternatives. But he believes the defined contribution market is still a ways away from broad usage of hedge funds. “The DC market is increasingly modeling itself after defined benefit plans. But sponsors still have to struggle with different issues like daily cash flows and minimizing the risk that individuals will fall short of their retirement needs,” he says.

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