CONTRIBUTORS
Tony Davidow, CIMA®
Senior Alternatives Investment Strategist
Franklin Templeton Institute
In this episode of the Alternative Allocations podcast series, I had the opportunity to speak to Jonathan Epstein about the work that Defined Contribution Alternative Association (DCALTA) has been doing to educate key stakeholders about the merits of including alternatives in defined contribution plans. Defined benefit (DB) plans have used alternative investments in a very meaningful way for decades, but alternatives have been limited in defined contribution (DC) plans.
Alternative Diversification among Institutional Investors
Sources: CAIA Association and Preqin. Diversification does not guarantee profit or protect against risk of loss. As of February 5, 2023.
I began by asking Jonathan to describe DCALTA and its mission. Jonathan indicated that he founded DCALTA in 2015 to focus on the advantages of including alternative investments in DC plans. He recognized the need to educate all stakeholders about the merits, including plan sponsors, consultants, alternative investment providers, recordkeepers, and regulators, among others. DCALTA performs independent research and writes white papers to help the extended community understand the challenges and opportunities.
I wanted to understand why there has been such a big difference in allocations to alternatives in DB and DC plans, and what steps can be taken to make these valuable investments more broadly available. I asked Jonathan about the DOL letter1 suggesting the inclusion of private equity in retirement plans, and the impact that it had on the industry.
Jonathan pointed out that large DB plans often have CIOs overseeing their asset allocation, as well as dedicated resources identifying and conducting due diligence on funds. Consequently, these funds often have healthy allocations to alternatives and often much better results. However, he noted that, “there are 718,000 401(k) plans that really need to have diversification and access to private equity, private credit, infrastructure, commodities, and real assets.”
I asked Jonathan about the concerns of the regulators, and he noted a few key ones—liquidity, pricing, product structure, and education for plan participants—all wrapped around fiduciary responsibility. He indicated that progress has been made over the last several years, and the newer product structures help in addressing some of these issues. Jonathan mentioned that interval funds, collective investment trusts, and managed accounts are product structures that are beginning to gain traction in DC plans.
With the progress made over the last couple of years, and the increased collaboration across key stakeholders, I wondered what the allocations to DC plans may be in the next five years. Jonathan stated that, “five years from now, I would think that an allocation of 10%-15% spread across different strategies will be normal.” Let us hope that will become the norm as it would benefit retirees.
Endnote
1. Source: US Department of Labor. “U.S. Department of Labor Supplemental Statement on Private Equity in Defined Contribution Plan Designated Investment Alternatives | U.S. Department of Labor.” December 21, 2021.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal.
Investments in many alternative investment strategies are complex and speculative, entail significant risk and should not be considered a complete investment program. Depending on the product invested in, an investment in alternative strategies may provide for only limited liquidity and is suitable only for persons who can afford to lose the entire amount of their investment. Diversification does not guarantee a profit or protect against a loss.
“Secondaries” is the term related to private offerings (typically structured as partnerships, led by investment managers as the General Parter, or GP) where a new investor, or secondary buyer, purchases an existing investor’s commitment to a private equity fund and effectively becomes a replacement investor as a limited partner (LP).
An investment in private securities (such as private equity or private credit) or vehicles which invest in them, should be viewed as illiquid and may require a long-term commitment with no certainty of return. The value of and return on such investments will vary due to, among other things, changes in market rates of interest, general economic conditions, economic conditions in particular industries, the condition of financial markets and the financial condition of the issuers of the investments. There also can be no assurance that companies will list their securities on a securities exchange, as such, the lack of an established, liquid secondary market for some investments may have an adverse effect on the market value of those investments and on an investor’s ability to dispose of them at a favorable time or price. Past performance does not guarantee future results.