DCIIA Analysis Finds that Strong Case Can Be Made for Including Illiquid Assets in Default Portfolio Designs

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After examining the pros and cons of using illiquid assets in a defined contribution (DC) framework, the Defined Contribution Institutional Investment Association (DCIIA) finds that a strong case can be made for including such assets in DC plans.

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“After a thorough examination, we found that there is value in adding alternative asset classes in default portfolio designs of DC plans," said Lew Minsky, Executive Director of DCIIA.

After examining the pros and cons of using illiquid assets in a defined contribution (DC) framework, the Defined Contribution Institutional Investment Association (DCIIA) finds that a strong case can be made for including such assets in DC plans.

With a significant amount of ongoing discussion about whether and how to use illiquid assets in a DC framework, DCIIA’s Investment Policy & Design Committee conducted a two-year project encompassing legal, operational, investment, and plan sponsor perspectives regarding the inclusion of alternative assets within DC plans.

The committee identified three categories of illiquid investments commonly considered in plan design: hedge funds, private real estate and private equity. It also reviewed best practices for integrating these investments into DC plan portfolios with a special focus on qualified default investment alternative (QDIA) asset allocation portfolios. The committee also evaluated four case studies:

  •     Alternatives included in custom target-date funds
  •     Custom risk-based portfolios with 20% allocation to illiquid assets
  •     Total allocation portfolio in a hybrid retirement plan
  •     Management of illiquid assets through risk-testing requirements

“After a thorough examination, we found that there is value in adding alternative asset classes in default portfolio designs of DC plans. These assets can provide significant potential for improved total return performance and can help serve as an important tool to diversify portfolios, reduce reliance on traditional equities and bonds, decrease volatility, and mitigate against downside risk,” said Lew Minsky, Executive Director of DCIIA.

The examination also reviewed some of the key considerations for early adopters of this strategy, including the determination of fair market value, liquidity management, and management fees. The analysis found that valuation and trading issues with illiquid assets are manageable, as there are numerous precedents for non-market pricing methods and that liquidity needs can be managed as part of broader allocation. As for risk, the analysis revealed that these risks are related primarily to the inflexibility during a severe downturn. In normal markets, options for exiting illiquid vehicles are available, while in periods of severe market stress, those options will be limited and that provisions are needed for participant-level liquidity though all market cycles.

A copy of the analysis can be obtained by clicking on the link below.

"Capturing the Benefits of Illiquidity"

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About DCIIA:

The Defined Contribution Institutional Investment Association (DCIIA) is a nonprofit association dedicated to enhancing the retirement security of American workers. Toward this end, DCIIA fosters a dialogue among the leaders of the defined contribution community who are passionate about improving defined contribution outcomes. DCIIA members include investment managers, consultants, law firms, record keepers, insurance companies, plan sponsors and others committed to the best interests of plan participants. For more information, visit: http://www.dciia.org.

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Ted Godbout, Director of Communications and Public Relations
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