Incorporating Alternatives - A Plan Sponsor's Perspective

Diversification and potentially higher returns are often cited as the main reasons for those advocating for increased alternative investment adaption among plan sponsors and participants. Do you agree with those points or do you see different benefits (if at all) from incorporating alternatives?

We agree that enhanced diversification and potentially higher returns are the main reasons for adding alternatives exposure to savings plan investment lineups. To achieve these important objectives, Lockheed Martin Investment Management Company (LMIMCo) recently launched a private real estate strategy within our custom LMIMCo Target-Date Funds.  There are also other related benefits of adding alternatives to Defined Contribution (DC) plans.  Whether as a core option, or as part of a target-date fund series, a DC plan can provide participants with access to alternative investment vehicles they traditionally may not be able to obtain.  Equally important, a DC plan may allow participants to access these alternatives via an institutionally priced vehicle.

Lack of participant understanding on alternatives and other sophisticated options is often cited by studies as the biggest reason why plan sponsors have yet to adapt alternative options en masse, do you agree with that sentiment, and if so, how would you go about any hypothetical education campaigns on the matter for participants?

Lack of understanding on alternatives is cause for concern, especially if these investments are offered as a core option, so yes, we agree with the sentiment. Like all offerings on the DC investment menu, providing participants with quality education and communication materials is key and warrants a focused effort. LMIMCo coordinates closely with our plan sponsor and recordkeeper to deliver effective communication materials through multiple media channels, including electronic delivery, webcasts, traditional mailings, etc. In addition, plan sponsors may want to consider exposure limits or other restrictions, if alternatives are offered as a core option.

Liquidity is often seen as another major obstacle towards adapting alternatives in a DC line-up - in your view, can a liquid structure like an ETF be a simple and satisfying enough workaround for the DC industry? What are your thoughts on incorporating them into target-date series?

Although Exchange Traded Funds (ETFs) can provide a simple and viable solution for most liquidity needs, ETFs are not a guaranteed source of sufficient liquidity. ETFs could, for example, be depleted by a run on the strategy by participants.  LMIMCo uses real estate ETFs to provide daily liquidity to our private real estate allocation in the LMIMCo Target-Date Funds. We rigorously researched and debated the proper level of ETF liquidity necessary to support the allocation to private real estate, and we expect that under most market environments this ETF cushion will provide ample liquidity. In the unlikely event, however, that participant outflows drain necessary liquidity from the strategy, we have identified additional sources of liquidity to meet daily redemptions. 

How do you suggest working with DC investment committees to encourage buy-in, and are there advantages to plans with DB operations and experiences with alternative investments when doing so?

Every committee has different personalities, biases, objectives, risk tolerances, etc. and therefore we cannot make a blanket statement as to how one specific committee may best be persuaded. However, just as with participant education and communication, ensuring the committee is up-to-speed on the topic and encouraging each member to thoughtfully consider what is best for the plan participants are both key.

There are obvious advantages for those savings plans that are served by investment fiduciaries, like LMIMCo, who have experience with alternatives in their Defined Benefit (DB) plans. Investment expertise, operational know-how and a suite of fully vetted investment managers cannot be created overnight. Also, it’s worth noting that alternative investment providers expect that future investment opportunities will become more available in the DC world over time. These providers may be more flexible as to certain terms, such as lower management fees, or more willing to innovate for operational requirements, such as redemption rights and valuation needs, with existing DB investors than they would for a brand-new relationship.