Providing alternatives in a DC context

As DB plans become increasingly rare and the prevalence of DC plans increases, pension plan sponsors are continuously looking for ways to provide investment options that can achieve solid returns.

The volatility of the markets since the financial crisis and the desire to mimic the style of DB plans has helped plant the notion of providing alternative investment options to DC plan members, in the minds of plan sponsors. Alternatives, which could mean anything from real estate, to mortgages, to infrastructure to private equity and hedge funds, open up new possibilities for investors by providing lower volatility options that do not fluctuate as much as traditional equity funds.

“The volatility of the last 15 years has been so prolonged and extended, that it’s been very hard for our members to sit there and worry ‘are they going to have enough to retire,’” says Zaheed Jiwani, senior vice-president, client strategy with Greystone Management Investment Inc. at the Benefits Canada DC Investment Forum, held on Friday, September 28.

Volatility mitigation

In an alternative investment like real estate, for example, the capital value of the asset fluctuates (much like an equity investment would) the income from the investment remains stable. An interesting outcome since Jiwani says the volatility mitigation, something most investors are looking for, is “embedded in the [alternative] asset.”

Liquidity challenges
Investors are looking for a “state of Zen,” which Jiwani suggests is low volatility and low correlations, which comes, typically, from direct alternatives.

There are challenges in finding this Zen in the DC context, however. For example, transactions and the ability to buy and sell in traditional assets, such as equities, are immediate and therefore liquid. An investor can make a trade and sell in real time without delays.

However in the alternative world, investors are forced to deal with lag times. Money being committed today may take time to find the right asset—for example the purchase of a commercial building. And when redemptions are made, a sale in a different part of the portfolio might be necessary to pay for that redemption. Again, this may take time. At the same time valuations are not daily as they are in traditional asset classes.

Alternative setbacks
There is a lack of benchmarking for a number of alternative assets and they are often fraught with legal and regulatory restrictions that may hinder them from being in certain types of plans.

Jiwani says that when compared to the volatility of equities, alternative investments, such as real estate investment trusts (REITs), or other indirect investments in infrastructure do provide lower correlations and lower volatility. However, direct investment is optimal in terms of its lower correlations. Yet the challenges of liquidity remain.

So how does one provide those investments in a DC context?

Institutional parties (plan sponsors or vendors) could rebalance the portfolio between traditional and non-traditional assets, which allow for daily valuations and liquidity.

“We’re talking about building an optimal portfolio—which can be in target-date funds, target-risk funds or balanced funds,” he says. Equities and bonds remain the core of the portfolio but providing alternative assets as a portion of the investments, in a direct way, can help get closer to that ‘state of zen’ of an optimal portfolio with lower volatility.

Joel Kranc is director of KRANC COMMUNICATIONS in Toronto.