Investing July 18, 2017

One-Third of Alternative Investment Assets in Pension Funds

Among fund types, hedge funds saw the biggest drop in 2016.
Reported by

The world’s 100 largest alternative asset managers saw their assets rise 10% in 2016 to $4 trillion, according to Willis Towers Watson’s Global Alternatives Survey.

Among fund types, pension funds hold 33% of alternative assets, followed by wealth managers (15%), sovereign wealth funds (5%), endowments and foundations (2%), banks (2%) and funds-of-funds (2%).

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Real estate accounts for 35%, or $1.4 trillion, of that total, followed by private equity (18% and $695 billion), hedge funds (17% and $675 billion), private equity funds-of-funds (12% and $492 billion), illiquid credit (9% and $360 billion), funds of hedge funds (6% and $228 billion) and infrastructure (4% and $161 billion).

Among the various alternative categories, illiquid credit saw the greatest increase in assets in 2016, a 102% rise from $178 billion to $360 billion. The biggest drop was in hedge funds, which saw their assets decrease 10%, from $755 billion to $675 billion.

“As capital supply and competition have increased in some segments of the illiquid credit universe, yields are not always offering sufficient compensation for illiquidity and risk,” says Brad Morrow, head of manager research, North America, at Willis Towers Watson. “At the same time, we have seen some withdrawal of capital from hedge funds in the face of high fees, skewed alignment of interests and performance headwinds. It appears the growing groundswell of negative sentiment that has arisen due to the aforementioned issues is now showing up in the decisions of asset allocators.”

Willis Towers Watson’s full report on alternative assets can be downloaded here.

Ask the Experts July 18, 2017

(b)lines Ask the Experts – Consequence of Offering Non-Eligible Investments

“What is the consequence of a plan that, though written to permit only 403(b) eligible investments (403(b)(1) fixed/variable annuities and /or 403(b)(7) custodial accounts (mutual funds)), actually offers investments that do not qualify as 403(b) investments in  plan operation? Is this a defect that can be self-corrected?”
Reported by

Stacey Bradford, David Levine and David Powell, with Groom Law Group, and Michael A. Webb, vice president, Retirement Plan Services, Cammack Retirement Group, answer: 

First of all, the Experts assume that you are not referring to a 403(b)(9) retirement income account of a church plan here, as investments outside what would normally be permitted in a 403(b) plan are permitted in such accounts, and thus an operational failure would not exist for the fact pattern you provide.

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For all other plans/accounts, a failure does indeed exist. And the consequences of such a failure, though it is an operational error and not a defect as to form in the plan document, can be substantial. The reason for this is that such defects are identified in the IRS Employee Plans Examination Guidelines for 403(b) Plans (specifically Section 4.72.13.9.1) as causing the plan to fail to be a 403(b) plan. Two specific examples are provided, as follows:

  • Example 8: ABC Foundation, an Internal Revenue Code (IRC) 501(c)(3) organization maintains an annuity plan intended to be an IRC 403(b) plan. Foundation makes both elective deferrals and employer contributions that are not elective deferrals to individual investment accounts (not mutual funds) for each of its employees. Foundation purchases annuity contracts for employees at their retirement. The arrangement is not an IRC 403(b) plan.
  • Example 9: Employer A is a public education organization maintaining a plan intended to be an IRC 403(b) plan. All contributions under the plan are invested in life insurance policies for its employees. Because life insurance must be incidental to the primary purpose of providing retirement benefits, the plan is not an IRC 403(b) plan.

A plan level failure, which causes a plan to fail to be a 403(b) plan, is the most severe type of plan failure. In theory, the Internal Revenue Service (IRS) could disqualify the entire 403(b) plan upon audit, which would result in immediate taxation of all account balances in the plan to all participants as well as other taxation and withholding consequences. Obviously, this is not a desirable outcome, and, in practice, such disqualification is not a common occurrence. But it does underscore the significance of this type of plan defect.

As for possible correction, the IRS Employee Plans Compliance Resolution System (EPCRS), which provides the corrective procedures for retirement plans (including 403(b) plans), is silent as to the correction of this specific defect. Given the severity of the failure, it would be prudent for the plan sponsor to contact counsel with specific expertise in such matters for guidance as to how to approach the IRS on this issue.

 

NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.    

Do YOU have a question for the Experts? If so, we would love to hear from you! Simply forward your question to Rebecca.Moore@strategic-i.com with Subject: Ask the Experts, and the Experts will do their best to answer your question in a future Ask the Experts column.

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