The Case for Alternatives in Retirement Portfolios


Advisors should use all asset classes—not just stocks and bonds—to help clients achieve retirement savings goals through bad times and good.

These were among the recommendations of financial professionals at a seminar in New York City on Tuesday. Clients can get spooked by a bad month or week in the stock market, they warned, and sometimes it compels them to junk advisors’ carefully crafted retirement plans.

What should a financial professional do for those whose risk tolerance is small?

Consider investments in a retirement plan that has little correlation with the stock market, including hedge funds, private equity, real estate and other untraditional, or alternative, investment vehicles, they said.

They complained that few target-date retirement funds have alternative investment options.

They also argued that clients saving for retirement should do more than just stocks and bonds. And they contended that, in order to make a significant difference in a portfolio, a client approaching or in retirement should have at least 10 percent of retirement funds in alternative investments. That, they said, will provide them a better long-term return, with fewer scary periods of poor performance.

David Adler, a senior advisor, said defined contribution plans tend not to use alternative investments. However, he said, that is not true in the less popular defined benefit retirement plans. “They are all about using alternatives,” he said.

Panelists also noted that institutional investors already are using these untraditional strategies, with an average of 25 percent of portfolios using alternatives.

Adler and other panelists pointed to a study showing alternatives are an effective retirement plan option, especially in target-date funds.

New research, panelists said, should prompt advisors to reconsider traditional retirement planning.
The paper, by risk management firm Willis Towers Watson and Angela Antonelli, executive director of Georgetown University’s Center for Retirement Initiatives, contends that broadening investment alternatives in a target-date fund structure enhances returns.

“Including these assets classes can improve expected retirement income and mitigate loss in downside scenarios,” according to the report, titled, “The Evolution of Target Date Funds: Using Alternatives to Improve Retirement Plan Outcomes.”

A diversified target-date fund portfolio generates about 17 percent more than an undiversified portfolio for each $100,000 in annual pre-retirement wages, the report said.

Having alternative assets in a defined contribution plan in retirement, according to the study, improves the probability of not running out of money over a 30-year retirement period and “provides higher expected returns and lower downside risk at the time of retirement and lower downside risk.”

Jason Shapiro, director of investments with Willis Towers Watson, which works with large institutional clients, said the goal of paper was to change the retirement planning marketplace, including how regulators view it. He noted that the retirement center is talking to the U.S. Department of Labor about allowing more alternatives in defined contribution plans.

Shapiro argued that, while equities provide strong returns over the long term, the case for holding more than just stocks is that it can take them long periods to obtain their strong returns. In the meantime, sometimes over 10-year return periods, equities could hurt those in retirement during shorter holding periods.

Alternatives can smooth out returns during periods when equities are doing terrible, such as the lost decade at the beginning of the century, he said.

Shapiro and other panelists said the case for alternatives is underscored by the recent decade, during which stocks shined. When stocks return to the mean, they argued, that will have an impact on investors in the middle of building retirement nest eggs.

“To mitigate that volatility,” alternatives can “have a really strong effect on wealth accumulation,” Shapiro said.