Changes Suggested to Close Performance Gap with Defined Benefit Plans
NEW YORK, June 6, 2013 — Broadening the investment options available to defined contribution (DC) retirement plans to include real assets, emerging market equities and debt, and liquid alternatives could improve risk-adjusted returns while reducing volatility and providing better protection against inflation, according to a white paper from BNY Mellon.
The results are published in the recent white paper, 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," said Robert G. Capone, executive vice president, BNY Mellon Retirement Group, and the author of the report. The report attributes the limited range of investment options included in DC plans as the primary reason for their inability to match the performance of defined-benefit (DB) plans. DB plans tend to incorporate a range of non-traditional assets.
The report notes 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 percent 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, BNY Mellon said.
"Equities comprise a higher percentage of the DC portfolios than they do of DB portfolios," said Capone. "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."
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 (TIPS), real estate investment trusts (REITS), commodities and natural resource equities.
Combining emerging markets equity and fixed income would provide a more blended and balanced approach than allocating only to emerging markets equities, the report said. 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, according to the report.
BNY Mellon sees liquid alternatives as a way to provide DC participants with strategies that have a low correlation to equities market. "There is a wide range of liquid alternative strategies," said Capone. "So, we are using three hedge fund indices as proxies for this asset class."
BNY Mellon Investment Management is one of the world's leading investment management organizations and one of the top U.S. wealth managers, with $1.4 trillion in assets under management. It encompasses BNY Mellon's affiliated investment management firms, wealth management services and global distribution companies. More information can be found at www.bnymellon.com.
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