The adoption of alternative investments in defined contribution, or DC, plans continues to be limited, but recent research from Cerulli Associates highlights how asset managers are seeking to make inroads via collective investment trust and interval fund structures.
A collective investment trust, or CIT, structure is a group of pooled accounts held by a bank or trust company. The financial institution groups assets from individuals and organizations to develop a single larger, diversified portfolio. There are two types of collective investment funds: A1 funds, grouped assets contributed for investment or reinvestment; and A2 funds, grouped assets contributed for retirement, profit sharing, stock bonus, or other entities exempt from federal income tax.
According to The Cerulli Report – U.S. Defined Contribution Distribution 2024: Addressing the Obstacles to Inclusion of Alternatives in DC Plans, about one-quarter of asset managers report they currently offer each, and 17% and 25% of asset managers report they are considering offering CIT and interval fund structures, respectively, to DC plans in the next two years.
Cost, liquidity, and plan sponsor inertia have hindered adoption of alternative investments in the DC channel, according to Cerulli. Alternative investments are typically more expensive and can include performance fees and other embedded operational costs. Moreover, alternative investments often involve long lockup periods – a kind of illiquidity in direct conflict with DC plans, where it is expected for participants to be able to change their investment allocation without liquidity restraints. Increasingly, one of the more notable challenges to adoption is plan sponsor inertia. Over the last five calendar years, nearly one in six asset managers (17%) view plan sponsor inertia as a serious challenge, while approximately three out of five (62%) within Cerulli’s sample view it as a challenge to innovation in the DC space.
Addressing sponsor concerns through strategic product structures will be important for asset managers. “The most optimal structures will be those that make alternative investments more accessible and attractive to DC plan sponsors,” said Idin Eftekhari, senior analyst at Cerulli. The research cites the viability of CITs as a packaged product given their less stringent liquidity and reporting requirements relative to mutual funds. According to the research, CITs are the most popular vehicle of choice (28%), slightly edging interval funds (25%).
Target-date funds will likely be a focal point. Half of managers (52%) expect alternative investments will be incorporated through a custom target-date fund, while 43% say that it will occur through a white-label fund of funds, according to Cerulli’s research. Custom target-date funds, for instance, can provide exposure without requiring participants to make difficult choices regarding complex investments.
Looking ahead, Cerulli expects the adoption of alternative investments in the DC space to continue to grow incrementally. Addressing liquidity and cost concerns while tailoring strategies to meet plan sponsors’ specific needs may further facilitate this upward trend.
From a distribution perspective, Cerulli recommends target-date managers – and other DC-focused asset managers seeking to incorporate alternatives into DC-focused products – establish strategic relationships with alternative investment managers that may lack direct access to the DC ecosystem. These collaborations could streamline the integration of alts into DC plans by offering ready-made investments that appeal to DC plan sponsors and participants.
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