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The Secret Ingredient in BlackRock’s Imitation Pension Fund

Asset managers are upping their REITs allocations in defined contribution funds, as the industry works to improve returns and reduce volatility.

Asset managers are working to make target-date funds — the go-to defined contribution vehicle — look more like what preceded them: defined benefit plans. DB plans have historically delivered higher investment returns with less volatility than their pay-as-you-go counterparts, in part due to a broader investable universe.

A number of multi-asset firms have looked to one product to help bridge the DC-DB divide: real estate investment trusts, or REITs.

Target-date funds are big and growing business for money managers. As they continue to attract investors, firms’ standalone offerings — primarily actively managed funds — are languishing.   

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From 1975 to 2017, a target-date portfolio that included publicly traded REITs outperformed a real estate-free equivalent by about 40 basis points per year with less risk. Wilshire Funds Management constructed and optimized these back-tested model portfolios, with REIT allocations ranging from about 15 percent for younger workers to 7 percent for those nearing retirement age. It is worth noting that Wilshire’s annual study was commissioned by REIT lobbying group Nareit.

REITs have been a mainstream product for decades. REITs were modeled on mutual funds and gave mainstream investors access to commercial real estate once dominated by America’s richest families through private companies. REITs gained critical mass in the 1990s, after a commercial real estate crisis put pressure on controlling families.

According to the Wilshire study, 60 percent of target-date funds have a dedicated allocation to REITs. BlackRock, AXA, MFS, and Schwab have the most aggressive allocations, according to separate research Nareit conducted for Institutional Investor. BlackRock leads: its LifePath Index Fund 2060 had 18.2 percent dedicated to the property vehicles. According to the industry group, 1 to 2 percent of the REIT total is embedded in the target-date fund’s other equities exposure — say the S&P 500. REITs specifically account for the remainder.

AXA also approaches the Wilshire study’s model allocations. Its 2060 fund carved out 8.9 percent for REITs, while MFS and Schwab each allocated about 8 percent in their 2060-dated DC funds. Other asset managers that dedicated a meaningful percentage to the category include PIMCO, Invesco, and J.P. Morgan Asset Management. 

Defined benefit plans, which the majority of workers once relied on for retirement income, have long included alternative assets such as real estate, commodities, private equity, and a variety of hedge funds strategies. Pension plans have in turn had higher returns and lower volatility than most 401(k) plans, which now are the primary mechanism for retirement saving in the U.S.

Most institutions concentrate real estate exposure through illiquid private funds. Such alternatives are often hard to add to defined contribution plans because they can’t be properly valued on a daily basis. REITs, however, are publicly traded securities, and represent between 15 and 20 percent of the investable commercial property market, according to Nareit. 

With asset managers adding REITs to target-date funds, “mainstream investors get a chance to outperform sophisticated institutions,” said John Worth, the group’s head of research.

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