More recently, though, DC plans have started to refocus on investing, looking closely at their default strategies, and in particular the early phase of those strategies. They are making changes to what have typically been fairly simplistic approaches, usually characterised by a large, if not 100%, allocation to passive global equity. Among the catalysts sparking these changes: a desire for greater diversification, an improvement in risk-adjusted returns and the ability to mitigate downside risk should equity markets face more turbulent times.
EFFICIENT FRONTIER WITH AND WITHOUT ALTERNATIVE RISK PREMIA
Source: J.P. Morgan Asset Management as at March 2018. 1 In the early phase of the glide path, with more than 25 years to retirement, a typical UK DC plan asset allocation is 100% global equity. By the late phase, with less than 10 years to retirement, the portfolio is 25% global equity, 25% DGF, 37.5% Gilts and 12.5% cash.
One such approach – alternative risk premia (also known as alternative beta) strategies – is emerging as a powerful tool to bolster the risk-return profile of the default strategies in DC plans. Offered in lower cost, liquid and transparent vehicles, these strategies gain exposure to risk premia that arise from behavioural biases, structural constraints or rational risk preferences. With very low correlation to traditional asset classes, alternative risk premia strategies can improve the overall risk-return profile for end investors by providing a more diverse risk factor profile. In short, they act as a different driver of portfolio returns.
DC plans are discovering that by adding an alternative risk premia strategy they can increase portfolio efficiency by reducing expected volatility. What is less well understood: These strategies can be used effectively in the early and middle, as well as the final, stages of a plan’s glide path.