Key Takeaways
- • The DOL's June 2020 rules allow defined contribution plans such as 401(k)s to include private equity assets, with customized asset allocation strategy funds, including target-date funds, cited as the preferred vehicle.
- • Only about one in ten 401(k) plans offer alternative investment options within their target-date fund lineups, according to a recent PGIM survey of DC plans.
- • Rising correlations among stocks, bonds, real estate and commodities, driven by low interest rates and global interconnection, have pushed investors toward liquid alternatives such as 130/30, market neutral, event-driven and merger arbitrage strategies.
- • Current SEC rules limit alternatives to accredited investors, though the SEC is reportedly considering proposals to open liquid alts to all investors.
- • Liquid alts performed well in the dot-com crash of 2000/2001, the Great Recession of 2008 and the recent pandemic-induced selloff, though their returns have been uneven and fees remain a barrier.
Summary
Liquid alternatives may soon become available in defined contribution retirement plans, according to MutualFunds.com. The commentary frames the trend around the erosion of diversification benefits: correlations among traditional asset classes, including stocks, bonds, real estate and commodities, have risen in recent years, particularly during the Great Recession and the Coronavirus pandemic. Low interest rates and a more interconnected global economy have reduced the non-correlation that investors have historically relied upon.
Liquid alternatives, which package strategies such as 130/30, market neutral, event-driven and merger arbitrage into mutual funds and ETFs, are presented as a response. The article cites a Mackenzie guide to liquid alts and notes that long-short credit strategies can also produce uncorrelated returns. Adoption by retail investors has been limited, in part because alternatives are rarely available in 401(k) plans. A recent PGIM survey of DC plans found that only about one in ten offered alternative options within their target-date fund lineups, and fewer offered standalone alternative mutual funds.
The regulatory landscape is shifting. In June 2020, the Department of Labor created rules permitting DC plans to include private equity assets, arguing this would not violate fiduciary duties under sections 403 and 404 of ERISA, and suggested that customized asset allocation strategy funds, including target-date funds, were a suitable vehicle. Separately, SEC rules currently restrict alternatives to accredited investors, and the SEC is reportedly considering proposals that would extend access to all investors. Proposed ERISA amendments on competitive fee provisions could also encourage inclusion in target-date funds and DC plans. Fee-related litigation risk remains a key concern cited by plan sponsors, since alternatives are typically among the most expensive mutual fund categories.
Performance is mixed. Given the strength of the equity market and high fees, many liquid alternatives funds have lagged, which the article notes is consistent with their intended low correlation to stocks. The strategies performed as diversifiers during the 2000/2001 dot-com crash and the 2008 financial crisis, and performed well during the pandemic-induced selloff, though the breadth of outperformance was less than in prior downturns. The article concludes that alternatives may offer diversification value and that wider adoption in 401(k) plans could help reduce fees over time.
Liquid alternatives, which package strategies such as 130/30, market neutral, event-driven and merger arbitrage into mutual funds and ETFs, are presented as a response. The article cites a Mackenzie guide to liquid alts and notes that long-short credit strategies can also produce uncorrelated returns. Adoption by retail investors has been limited, in part because alternatives are rarely available in 401(k) plans. A recent PGIM survey of DC plans found that only about one in ten offered alternative options within their target-date fund lineups, and fewer offered standalone alternative mutual funds.
The regulatory landscape is shifting. In June 2020, the Department of Labor created rules permitting DC plans to include private equity assets, arguing this would not violate fiduciary duties under sections 403 and 404 of ERISA, and suggested that customized asset allocation strategy funds, including target-date funds, were a suitable vehicle. Separately, SEC rules currently restrict alternatives to accredited investors, and the SEC is reportedly considering proposals that would extend access to all investors. Proposed ERISA amendments on competitive fee provisions could also encourage inclusion in target-date funds and DC plans. Fee-related litigation risk remains a key concern cited by plan sponsors, since alternatives are typically among the most expensive mutual fund categories.
Performance is mixed. Given the strength of the equity market and high fees, many liquid alternatives funds have lagged, which the article notes is consistent with their intended low correlation to stocks. The strategies performed as diversifiers during the 2000/2001 dot-com crash and the 2008 financial crisis, and performed well during the pandemic-induced selloff, though the breadth of outperformance was less than in prior downturns. The article concludes that alternatives may offer diversification value and that wider adoption in 401(k) plans could help reduce fees over time.
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