Defined Contribution  

DC allocations to alternatives branded 'meaningless'

DC allocations to alternatives branded 'meaningless'

Defined contribution portfolio allocations to alternative investments have been branded "meaningless" by experts.

Many pension investors turn to alternatives, such as hedge funds, private equity and real estate, with the aim to protect against market downturns, as well as access any potential illiquidity premium.

But according to pension consultancy River and Mercantile Solutions this allocation was pointless.

Even after a 30 per cent increase, the returns from the allocation in terms of their contribution to a DC portfolio would be negligible, said Niall Alexander, head of DC solutions at the firm.

In a survey of the sector last year Aviva had found the average DC allocation to the alternatives asset class was 4.3 per cent.

And the survey found some 252 schemes and insurers in the UK and Europe intended to increase this amount by a third, taking the allocation to 6.5 per cent.

Mr Alexander said: "On the face of it, the move to increase exposure to alternatives, which can include a range of investments including hedge funds and infrastructure, makes a lot of sense for schemes.

"But unless a sizeable portion of a scheme’s assets is directed into them, they risk getting swallowed up by other assets to which schemes make larger allocations."

Mr Alexander said savers also faced higher charges for that portion of their portfolio. 

"If your allocation does pay off, it risks being pretty meaningless compared to the other 93.5 per cent of your portfolio," he concluded.

The alternatives approach mirrors that taken by large, institutional investors in control of billions of pounds in defined benefit pension funds.

In a survey of UK defined benefit schemes in 2018, investment consultant Mercer found the schemes held 25 per cent of assets not classed as equities and bonds. 

Mr Alexander concluded that while there was "much noise" in the industry about the benefits of alternatives, schemes needed to "go big or go home". 

"Given we can’t go big in DC, the likelihood of alternatives acting as a ‘silver bullet’ for schemes and solving market event issues is much diminished," he said.

Darren Cooke, chartered financial planner at Red Circle Financial Planning in Derbyshire, agreed alternatives in DC schemes were "too expensive and not worth it".

"Hedge funds, for example, destroy value and do not add returns. They are a waste of time," he said.

He said he did not allocate any client money to alternatives.

Mr Cooke said pension investors should instead stick to the asset classes that made up the bulk of the portfolios. 

"If the majority of the portfolio is in equities and bonds, adding 5 per cent allocation is just for show and not worth it," he said.