Broadening the investment options available to American DC plans to include real assets, emerging market equities and debt, and liquid alternatives could improve returns while also reducing volatility and providing inflation protection.
The results are published in a white paper from BNY Mellon, called Retirement Reset: Using Non-Traditional Investment Solutions in DC Plans.
“Traditional DC plans do not provide the level of diversification and risk balance that plan participants require to achieve their retirement goals,” says Robert G. Capone, executive vice-president with BNY Mellon Retirement Group and the author of the paper.
Read more: Providing alternatives in a DC context
He adds that the limited range of investment options included in DC plans as the primary reason for their inability to match the performance of DB plans.
The paper notes that non-traditional approaches could enhance the success of investors in the current environment, which it 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 the DC 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.
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Equities comprise a higher percentage of the DC portfolios than they do of DB portfolios.
“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,” explains Capone.
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, real estate investment trusts, commodities and natural resource equities.
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Combining emerging markets equity and fixed income would provide a more blended and balanced approach than allocating only to emerging markets equities.
The more balanced approach has the potential to reduce portfolio volatility and diversify country and currency risks than could be accomplished with only emerging markets equities.
Liquid alternatives are a way to provide DC participants with strategies that have a low correlation to equities market.
In the paper’s hypothetical back-tested scenarios, the addition of non-traditional exposures increased the annualized returns over the average DC plan in all cases.
The average risk decreased the most in the liquid alternatives portfolio. And risk also decreased by including real assets and the combined allocation to all three investments.
Only the merging markets exposure increased risk over the average DC plan. In that case, exposure to high-growth emerging markets also increased the average return more than any other portfolio scenario as well.