Broadening asset classes in order to provide more potential for returns while diversifying risk continues to be top of mind for plan sponsors. Defined benefit (DB) pension sponsors have been motivated to shift portfolio allocations, most notably de-risking through scaling back traditional equities, with a corresponding increase to lower-volatility fixed income.
Many defined benefit plan sponsors have also headed into alternative assets such as direct real estate, private equity and hedge funds. The total assets managed by the top 100 alternative investment managers globally reached $3.6 trillion this year, up 3% from 2015, according to a Willis Towers Watson survey. The research, which includes data about a diverse range of institutional investor types, shows that pension fund assets represent one-third (34%) of the top 100 alternative managers’ assets.
Real estate managers continue to have the largest share of pension fund assets, with 40%, followed by private equity funds of funds (PEFoFs) (20%), hedge funds (10%), private equity (9%), infrastructure (8%), funds of hedge funds (FoHFs) (7%) and illiquid credit (4%).
“The alternative asset management industry continues to be remarkably reliant on pension fund money and has earned a position of trust by delivering diversified returns via some of the most highly skilled investment teams around,” says Brad Morrow, head of manager research, North America, Willis Towers Watson. “However, there’s an ever-increasing demand for more alignment and lower cost.”
In defined contribution (DC) plans, participants generally get access to real estate and alternatives through a broad asset-allocation option.
Adding a range of high-income-generating assets to a traditional retirement-stage target-date fund (TDF) portfolio could boost income returns by nearly 40%, while providing comparable total returns and no increase in risk, according to research from Wilshire Funds Management under the sponsorship of the National Association of Real Estate Investment Trusts (NAREIT).
The PLANSPONSOR Defined Contribution Survey segregates real estate and real estate investment trusts (REITs) from the rest of the alternatives category, with take-up of these options looking much stronger than that for other types of alternatives.
Wilshire’s research is based on a variation of its income-oriented mean-variance optimization (IOMVO) model, which determines optimum levels of various portfolio assets that will produce a maximum total return for a specified level of risk, as well as for a specified level of income return.
Wilshire found that a traditional MVO-modeled portfolio that delivered a 2.37% annual income return, and a 5.37% annual total return with an 8% level of portfolio risk, could be enhanced with IOMVO modeling to deliver a greater annual income return of 3.25% and a comparable 5.27% annual total return with the same 8% level of risk.
“Portfolios that generate less income may require retirees to dig deeper into their savings to fund their expenses, potentially resulting in the depletion of their assets while they are still living,” says Wilshire Funds Management Chief Investment Officer (CIO) Joshua Emanuel. “Income-oriented portfolios with significant allocations to assets such as REITs, high-yield bonds, preferred stocks and non-U.S. developed stocks may help investors meet the challenge of producing income with less reliance on savings.”