“The fees are a massive trade-off,” said Schwartz. “The ability of higher fees to erode any diversification benefits and alpha over time is very real. … High fees can turn alpha into negative alpha. There’s no question that fees need to be looked at as an issue here.”
Rather than seek alpha from an outstanding hedge fund or private equity manager, target-date investors would be better off embracing diversification by adding more asset classes. Those benefits could probably be accessed at lower cost from the liquid alternative universe, said Schwartz, or in ETFs that replicate hedge fund strategies.
Creating a Better 401(k)
The Georgetown report’s authors argued that there’s a need for better investment options within defined contribution plans. While pensions typically include allocations to alternatives, most default investments within 401(k)s and 403(b)s do not, limiting themselves to stocks and bonds. When they were developed, defined contribution plans were not thought of as replacements for pensions as primary retirement savings vehicles and sources of retirement income, so they did not encompass the same range of investments.
In 2016, the average pension plan had more than 10 percent of its assets dedicated to hedge funds, real estate and private equity—and the average public pension had approximately 25 percent of its assets allocated to alternatives, according to the report.
Because of the marketing issues and the costs associated with alternatives, there’s an ethical question about whether plan fiduciaries should offer certain alternative asset classes in target-date funds, said Schwartz, as these funds have become the default investment of choice within qualified retirement plans. Until additional research is conducted, the question of whether the benefits of alternative allocations in target-date funds exceed the costs remains unanswered.
Nevertheless, the Georgetown/Willis Towers Watson researchers called on policy makers and plan sponsors to implement alternatives within retirement plans.
Even without policy maker action, Antonelli said, “plan sponsors with an interest in implementing portfolios with [alternative] asset classes can work with their advisors, custodians and record-keepers to implement solutions that enhance participant outcomes for a more secure retirement.”