Making The Case for Alternatives—Particularly Commercial Real Estate—in Defined Contribution Plans
Despite widespread use in institutional portfolios, alternative investments are not typically found in US defined contribution plans. Drew Carrington, Head of Institutional Defined Contribution at Franklin Templeton, and Tripp Braillard, Head of Defined Contribution Distribution at Clarion Partners, explain why perhaps they should be.
For a variety of reasons, the US defined contribution (DC) industry can be reasonably described as risk averse. Decisionmakers, from plan sponsors to consultants, generally seek to avoid any decision that might be perceived as risky, whether it’s plan design, investment choices or manager selection. In addition, ERISA’s standard of prudence (often referred to as the “prudent expert” standard), frequently is interpreted as “doing what everyone else is doing.” This is, of course, in addition to all of the important responsibilities of a fiduciary, such as regular meetings, thorough documentation, investment policies, and hiring experts.1
So, when it comes to a topic like alternative investments in DC plans, the first reaction for many DC decisionmakers is reflexive avoidance. Even before the investment case is made, or specific asset classes are considered, the reaction is often, “That sounds risky, I’ll wait until others have blazed that trail. We don’t want to be first.”
Institutional investors such as defined benefit (DB) plans, endowments and foundations have long enjoyed the benefits of alternative assets, including real estate. In fact, the average institutional investor allocates 10.1% to private commercial real estate.2 By comparison, Large US DC plans are dramatically underweight to alternative investments with just a 0.26% allocation within their target-date and balanced funds as of 2020.3
The underweight is true even compared to other nations’ daily valued DC systems, such as Australia’s Superannuation funds, which allocate over 11% to private assets, including real estate.4 Furthermore, real estate is the third-largest investable asset class and represents 11% of US investable assets. Of all investable US real estate, $10 trillion (89%) is private commercial real estate, while $1.3 trillion (11%) is listed real estate investment trusts (REITs).5
Why Commercial Real Estate in a Multi-Asset Portfolio?6
US DB plans have utilized private real estate for all of the reasons one might expect: private real estate can be a powerful diversifier, generally produces stable, income-based returns, and has inflation-hedging properties. And there’s no reason why DC plan participants shouldn’t enjoy these benefits, as well. Private real estate can be easily accessed through a professionally managed portfolio, such as a target-date fund (TDF), managed account or white-label, multi-manager portfolio (such as a real asset fund), providing participants with the same advantages that large institutional investors already experience.
Further, because a number of intrepid souls have blazed the trail, it means plans considering adding private real estate today will not be first or doing something new. The array of plan providers, such as custodians, recordkeepers, managed account providers and glide path managers, have all considered private real estate allocations, determined appropriate allocations and worked through operational issues that might arise. Most of the products available in the DC market today (there are over a dozen), have daily valuation, regular liquidity, and DC plan-friendly vehicle designs, such as using collective investment trusts to house the private real estate stakes. Today, assets in private real estate (not REITs) in 401(k) plans currently exceed $37 billion and are utilized in over 14,000 plans.7