BNY Mellon Recommends Expanding Investment Options

The white paper, from investment management firm BNY Mellon, examines the broadening of investment options available to DC retirement plans to include real assets, emerging market equities and debt, and liquid alternatives and how that could improve risk-adjusted returns while reducing volatility and providing better protection against inflation.

“Traditional DC plans do not provide the level of diversification and risk balance that plan participants require to achieve their retirement goals,” said Robert G. Capone, executive vice president, BNY Mellon Retirement Group, and the author of the paper, titled “Retirement Reset: Using Non-Traditional Investment Solutions in DC Plans.”

Capone attributed the limited range of investment options included in DC plans as the primary reason for their inability to match the performance of defined benefit (DB) plans, which tend to incorporate a range of non-traditional assets. Capone noted that non-traditional approaches could enhance the success of investors in the current environment, which he expects to be characterized by lower long-term expected returns, higher volatility and heightened inflation risk.

If DC plans were constructed more similarly to DB plans, approximately 20% of plan assets would be allocated to non-traditional strategies such as real assets, total emerging markets (which combine equities and fixed income) and liquid alternatives, BNY Mellon said.

 

“Equities comprise a higher percentage of the DC portfolios than they do of DB portfolios,” Capone said. “We believe that applying the best DB practices to DC plans would reduce equity risk and home country bias as well as thoughtfully incorporating alternative investments to increase diversification, return potential and downside risk management.”

The real asset portion of the DC portfolio proposed by BNY Mellon is designed to hedge against inflation and would include Treasury Inflation-Protected Securities (TIPS), real estate investment trusts (REITS), commodities and natural resource equities.

The combination of emerging markets equity and fixed income would provide a more blended and balanced approach than allocating only to emerging markets equities, according to Capone. The more balanced approach has the potential to reduce portfolio volatility and diversify country and currency risks than could be accomplished with emerging markets equities alone.

BNY Mellon sees liquid alternatives as a way to provide DC participants with strategies that have a low correlation to equities markets. “There is a wide range of liquid alternative strategies,” said Capone. “So, we are using three hedge fund indices as proxies for this asset class.”