Implications of Using Alternative Assets in Target-Date Funds

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Target-Date Funds

Implications of Using Alternative Assets in Target-Date Funds

David Dierking Dec 05, 2017

To learn more about target-date funds, click here.

Why Passive Is Becoming Passé

In response, an increasing number of funds have begun making changes. To address the “incomplete” issue, TDFs have been adding new assets into their portfolios, such as real estate, gold and junk bonds. These products offer a variety of risk/return profiles with lower correlations to traditional asset classes, and can help deliver better diversified portfolios with improved risk-adjusted returns.

While investors appreciate the low-cost nature of passively-managed index funds, they also appreciate the flexibility to make adjustments to their TDFs based on current market conditions. To address this concern, some fund providers have begun incorporating active funds back into the mix. This gives fund managers the ability to tilt the portfolio based on interest rate risks, equity valuations or any other reason they feel could impact shareholder returns.

The Evolution of the Glide Path

This is where alternative asset classes can help. A portfolio of large-cap, small-cap and foreign equities could be considered diversified, but these classes still have relatively high correlations to each other. Real estate and gold, for example, are much less correlated to equities and respond very differently to economic conditions. These kinds of assets can provide important risk-management benefits for investors nearing retirement or worried about severe market declines. Including these products in TDF glide paths can help address the needs of a more diverse investor base.

For a listing of alternative funds, click here.

Alternative Asset Classes to Consider

  • Commodities – These assets, including things such as gold and silver, are often more economically sensitive and considered a safe haven in times of uncertainty. Holding these assets is beneficial from a risk-management perspective, but can be costly, especially if holding the physical asset.
  • Real estate – S&P thought real estate was economically important enough to break it out from financials and give it its own sector in the GICS classification system. Owning actual real estate doesn’t make sense, but REITs make exposure to this sector easy, cheap and liquid. Real estate is already showing up in TIAA’s target-date funds.
  • Liquid alternatives – These are products that invest in non-traditional assets and strategies, such as managed futures and leveraged loans, and are designed to be easily tradeable on an exchange. That’s about where the benefits end, as liquid alternatives are often costly, complex, difficult to understand and lack transparency.
  • Private equity – Privately-held companies may have home-run potential, but they are costly to take a stake in, and are challenging to sell if you ever want to exit your position.
  • Hedge funds – These products have traditionally been available only to high-net-worth investors, but their high costs have led many of these funds to lag their benchmarks over time.

Click here for some things you should know before investing in alternative funds.

Key Considerations for Investors

The Bottom Line

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