Implementation Issues

The Georgetown researchers noted that including private equity, hedge funds and real estate within target-date funds would require more investor and plan sponsor education and more oversight by plan fiduciaries.

Unlike Vanguard, the authors of the Georgetown report did not think issues like liquidity, pricing, benchmarking, fees and governance would prevent the inclusion of alternatives in target-date funds.

“Defined contribution service providers’ capabilities have vastly improved,” said David O’Meara, head of defined contribution strategy at Willis Towers Watson, in a release. “Operational challenges, including the need for daily liquidity and daily pricing, and participant-controlled cash flows, can easily be addressed. This can already be seen in the increased use of custom funds in defined contribution plans.”

Schwartz fell more on Vanguard’s side of the argument, asking whether private equity, direct real estate and hedge funds made sense in plans.

He questioned the assumption that a 401(k) could handle the liquidity needs of its participants if it held relatively illiquid asset classes.

“I’m not so certain that a defined contribution plan would be able to respond to liquidity needs over a prolonged crisis period—not a day, week or quarter, but in a Great Recession-type environment,” said Schwartz. “I don’t know that they would be able to withstand the liquidity needs while having money locked up in something like a private equity fund.”

The Georgetown center paper also assumes that target-date funds would be able to choose the top managers in private equity and hedge funds, which is probably unrealistic. Large pensions are often unable to access any hedge fund or private equity opportunity they choose, and the best managers often have to refuse money.

Furthermore, there’s a great deal of dispersion in strategy and performance in the asset classes in the Georgetown report, said Schwartz. Actual outcomes would depend on manager selection, and there’s no evidence that target-date managers would be able to identify the best opportunities for their investors.

High fees could also bite into the modest benefits offered by alternative allocations, said Schwartz.