People might well ask why their alternative target-date fund isn’t keeping up with one at another 401(k) plan. That will require constant re-education of investment committees—a clique that’s always graduating and leaving. “I work with plan sponsors and the majority of the committee members are new within the last year,” Verdeyen says.
It doesn’t help that the clients themselves aren’t usually clamoring for alternative investments, she adds, unless it’s something that’s been in the news a lot like gold or crypto. Mercer doesn’t go in for that kind of thing with DC plans, she says.
Are Target Date Funds The Answer?
Given the logistical problems with stand-alone funds, Kennedy says Cerulli has seen alternatives appear as part of a sleeve in target-date funds, mostly those customized for larger plan sponsors.
Some well-known players that have added private (or direct) real estate to their target-date fund suites are JPMorgan, Prudential and Nuveen/TIAA.
The Defined Contribution Real Estate Council, a trade group whose members provide real estate investment products, recently said in a 2022 report: “Approximately $79.4 billion of DC capital is currently invested in private real estate, including $16.9 billion in vehicles structured for DC investors. … Out of 32 real estate investment managers surveyed, three-quarters reported they either had a product, or were actively developing or considering developing a product” for DC investors.
There’s likely going to be adoption for larger plans first, Kennedy says. “Only large plan sponsors can justify that they have the influence to get these target-date funds in the first place and they are typically off-loading liability to the investment manager,” he says. The target-date funds also limit the exposure of the private assets to make sure clients don’t have too much allocated to them, and that’s another way the liability is removed from the plan sponsor or consultant and taken on by the manager.
At the same time, it means the alternatives allocation is going to be fairly small in a lot of these funds, Doss says. “When we talk about the target-date funds that have a private real estate fund in them today, it’s a very small allocation. It could move the dial, but it depends on the percentage you put in there.” It could be as big as 15% or as small as 3%, so the window is small.
The guidance from the Department of Labor is also going to have to be more consistently approving of private assets, Doss and Kennedy said, yet that guidance that can change from one presidential administration to the next. (Consider how the regulatory fortunes of ESG investments turned from hostile to friendly between the Trump and Biden regimes.) Plan sponsors are going to need sophisticated committee members, perhaps people who have worked in the defined benefit side of the pension business.
The department sent out a guidance letter on June 3, 2020, at the request of two firms hoping to cater to this market: Pantheon Ventures and Partners Group. The two firms have developed private equity investments meant to be offered through collective investment trusts (or CITs), tax-exempt pooled investment vehicles that offer daily liquidity within ERISA retirement accounts.
While the department’s guidance letter said PE investments could indeed be proper, “private equity investments, however, present additional considerations to participant-directed individual account plans that are different than those involved in defined benefit plans. The liquidity component is key for defined contribution plan participants, as it is for target-date funds.”
For performance reasons, the funds should be comparable with those that don’t have the private equity component, the DOL said.
PGIM, the asset management arm of Prudential, has a private real estate product for DC plans. Josh Cohen, a managing director and head of client solutions for the DC space at PGIM, says there are operational challenges for investments that don’t trade or are valued in a daily way. But he says the private real estate class has proved for many decades that the challenges can be overcome.
“In almost all cases these are available within a broader, multi-asset professional managed solution like a target-date fund or a managed account,” Cohen says. “Most of them besides having the liquidity of that professionally managed solution typically will have a liquidity sleeve, for example, REITs, to handle the typical cash flow and rebalancing needs. And they also … provide a daily net price so that it can be valued.”
David Levi, head of Brookfield Oaktree Wealth Solutions, says his firm has both illiquid strategies with long lockups but also offerings with daily liquidity in things like listed infrastructure and listed real estate and renewables, investments that can be managed through vehicles like mutual funds and CITs that are appropriate to package in DC plans. There are also semi-liquid strategies, including those oriented around real assets, real estate, infrastructure and private credit—strategies whose liquidity ranges from monthly to quarterly. Still, he agrees that given the level of sophistication at many plan sponsors, these items are best arranged in a target-date fund rather than set free as stand-alone options in a DC plan.
Wagner says people hate investment losses even more than they love gains. If there’s a significant loss in a plan, participants will inevitably ask questions: Was there sufficient due diligence? Was there a kickback to the vendor? What type of disclosure was provided to the plan sponsor? “If those boxes aren’t checked off correctly or well, then there will be a class action lawsuit. … Because a very angry plan participant will drop a dime.”