Are retirement investors in the $1.1 trillion target date fund market being shorted by a lack of exposure to alternative investments?
A new paper from Georgetown’s Center for Retirement Initiatives suggests they are, and sets out to quantify just how much savers are potentially losing by investing in products that mostly split risk between equity and fixed-income exposure.
Only eight of the 41 TDF managers tracked by Morningstar include alternative investments like private equity, hedge funds, and real estate, according to the 2018 Target Date Fund Landscape Report. One fund’s series pulled its alternative exposure due to lack of demand.
That relative dearth of access is hurting TDF investors, argue analysts at the CRI, which teamed with Willis Towers Watson’s defined contribution advisory team to author “The Evolution of Target Date Funds: Using Alternatives to Improve Retirement Plan Outcomes.”
Plan sponsors’ “myopic” focus on fees in an era of common 401(k) litigation, alternatives’ illiquidity relative to equity and bond securities, and TDF managers’ lack of in-house expertise with alternatives have conspired against their use in TDFs, the paper says.
“For the most part industry-wide usage of alternatives has been very limited because those asset managers do not have the internal expertise with alternatives. Therefore, if a sponsor wants to add exposure to alternatives today, building custom funds is the most effective approach,” according to the paper.
How private equity fared
To test what participants may be missing from garden-variety TDFs, the analysts plugged alternative strategies into a baseline glide path based off 21 fund families.
To test the potential value of private equity, analysts replaced 10 percent of the baseline glide path’s equity allocation with private equity. A hypothetical full-career employee saw their retirement income increase with conservative and moderate private equity weights.
For those with the most savings, private equity increased annual retirement income by more than $11,000 when accounting for a moderate private equity allocation—which the research defines as 20 percent at the beginning of the baseline glide path, tapers to 10 percent at retirement, and ultimately to 0 percent 10 years after retirement.
Core real estate
While private equity seeks to outperform public equities, real estate investments are intended to diversify portfolios and provide downside protection.
In the paper, analysts replace portions of the baseline glide path with conservative and moderate allocations of real estate: 5 percent trending to 0 percent at retirement for the conservative model, and 10 percent trending to 5 percent at and through retirement for what the analysts call the moderate allocation model.