Show V/O:
This is Alternative Allocations by Franklin Templeton, a monthly podcast where we share practical, relatable advice and discuss new investment ideas with leaders in the field. Please subscribe on Apple, Spotify, or wherever you get your podcast to make sure you don't miss an episode. Here is your host, Tony Davidow.
Tony:
Welcome to the latest episode of the Alternative Allocations podcast series. I'm thrilled to be joined today by Jonathan Epstein of DCALTA. Welcome Jonathan.
Jonathan:
Thanks for having me.
Tony:
So maybe let's start with the basic, which is what is DCALTA? What is the mission? What are you trying to do?
Jonathan:
DCALTA stands for the Defined Contribution Alternatives Association. Most people say DCALTA or DCALTA, depending upon where you're from. I created it back in 2015 and it's to expand the use of different types of alternative investments and strategies within a defined contribution framework. DC plans are typically your 457(b) plans and your 401(k) plans.
Tony:
And I'll tell you, as you and I've been talking about for the last couple of weeks as we've been getting ready for this, this is a passion of not only mine, but Jenny Johnson, our CEO, when she was on my podcast, we specifically talked about this incredible opportunity that we see in having retirement assets being exposed to these great investments that we end up talking about all the time. So what's your mission? What are you trying to do with DCALTA?
Jonathan:
I would say that the simplest way to look at it is to create diversification through fairness. So, what we don't want is for large defined benefit pension plans to have large allocations to alternative investments. And then when we look over at the DC side of a lot of U. S. retirement plans that the allocations really are a rounding error. So that's what we're trying to solve for. I would say that our members are all focused mainly for the mission, which is to educate the community and all the stakeholders that are involved, not only on the DC side, but also on the alternative side. So we serve as, what I like to say, as a bridge to the information gap that exists between alts firms, alts managers, and DC stakeholders.
Tony:
And I think if we think back over the last couple years, there's kind of a big inflection point with the Department of Labor recognized that, to your point, defined benefit plans have historically made big allocations to alternative investments, but defined contribution plans, not so much. It had been fairly limited in all of that. And it seemed like that started, at least across the industry, this groundswell to say, “What do we need to do to better prepare all stakeholders to allow these into defined contribution plans, but to do it in an intelligent way?” And I think that's part of what your mission is all about. So how have we progressed that discussion over the last couple of years?
Jonathan:
Yeah, I would say since the first letter that was released. It's an information letter by the DOL, which was very positive. It went to a law firm that was representing two asset management firms that were focused on alts. And it specifically discussed private equity as an alternative. And again, it was very positive. And we had a different administration then because it was followed up about a year or two later with another information letter that was not as positive that tried to separate plan sponsors based on financial savviness, let's say. So those large, let's say, corporate defined contribution plans that also have the benefit of having large DB plans and CIOs that are overseeing these types of assets, they felt more comfortable allowing them to, let's say, allocate to different types of alternatives where we're not seeing it for the 718,000 401(k) plans that are out there that really need to have diversification and access to whether it's private equity, private credit, infrastructure, commodities, real assets, whichever we look through, that's why we exist and that's who our members represent.
Tony:
And I was going to ask you a little bit about that. Maybe you could just spend a minute talking about who are your members. And then who are the stakeholders in this - asset managers? Is it the regulators? Who are your stakeholders and who are you trying to discuss these key issues with?
Jonathan:
Great question. So we started looking at, and I come from the background of working from really the fiduciary perspective. So, I have my AIF, which is Accredited Investment Fiduciary, but I worked in my background with a lot of defined contribution plans of all different sizes. And I got to work with them, not only on their investments, but also really from the record keeping and the administration side. So I learned a lot about how the DC system works from all different aspects, and I think that then lends itself to who our members are.
So I feel really comfortable when we have record keepers that join DCALTA that are focused on education. They're focused on reaching out to their participants. Educating the plan sponsors on different types of whether it's investments, plan design, et cetera. And then we also have platforms that exist that also make it easier for advisors or consultants to talk about alternative investments with their clients.
It's not difficult for a consultant or an advisor to work with let's say, an individual where they can spend a lot of time with them, but when they talk with their retirement plan clients, they may be given a certain amount of time to explain a very intricate topic like what is private equity, how is it priced and how is it valued, et cetera.
But when we look at the members of DCALTA, again, record keepers, consultants, plan sponsors. We have a lot of fintech firms. We've gotten a lot of interest over the last, I would say, two years from firms that focus on digital assets and blockchain and securitization and fractionalization. And then we also have folks that are not necessarily consultants, but they volunteer and they're either in transition from different parts of different organizations that really take hold and they're experts, I would say, in their fields. They've gotten involved with a lot of the projects that we’re getting involved with at DCALTA, which is to work on principles to help move the industry forward.
So sorry for that long-winded answer, but our membership is really, they represent every facet of the U.S. retirement ecosystem is what I'd like to say.
Tony:
And I think that's important. I mean, you've got representation across the whole ecosystem. And I've read your research, which I think is really, really good. I've actually cited your research in a paper that I wrote about rethinking retirement and similar to the way that you've approached it, I've kind of looked at it originally from the lens of, I know how big pension plans are allocating capital and big allocations to alternatives broadly and private markets specifically represent a pretty significant portion of that over time.
And I think the intellectual argument is an easy one of why we would be adding this, but I want to get to the crux of this, and I think I know some of the answers to this, but I'd love for you to weigh in on it. I think part of what I hear, because we also have representation that are interfacing with folks in Washington around this, part of it is education.
How do we better educate people? Part of it is products. Do we have products that are really conducive, which are more liquid in nature? And clearly for a 401(k) plan, you're in and you're out. Individuals are making those decisions. You and I have talked in the past about the fiduciary sort of issues. So what's kind of the crux of the issues that's slowing this down and ultimately how as an organization are we helping to overcome that?
Jonathan:
Yeah, that's a great question. A big one. I would say that the challenges today are different than the challenges that we had five years ago. And thus, the reason why DCALTA focused on areas of liquidity. A lot of the private markets are illiquid investments, and that's not going to change. Private real estate, a building is a building, will always be illiquid.
And when we spent time on those issues within the DC construct and finding different areas of where liquidity can be sourced, whether it's in product, outside of product, whether it's within a range of different target date funds and someone's managing the liquidity for all of the different vintages.
These types of positions that we took as an organization were important, I think, and instrumental in moving us forward to where we are today. We also did the same thing on the valuation of illiquid assets and pricing them, and how should we as an industry move forward with looking at daily valuation?
That's key, right? So we're giving participants the ability to move in and out of funds on a daily basis and are products supposed to go into that mold, or do we take a step back and allow illiquidity and manage around it? And these are questions that we've all, and all the members that are on our committees, have really put forth some interesting perspectives on. And again, so our liquidity paper that came out which lays out a framework for plan sponsors, for advisors, consultants, everyone that touches the alternatives and the different investment strategies that make up that space as well as the valuation.
When we look at the challenges today and you bring up, for instance, litigation or anything like that, that may be from a DC corporate plan sponsor viewpoint, very challenging. I would actually say today that the story is changing on diversification and that the litigation may come to those plans that aren't diversifying enough.
You know, I feel very strongly, but again, it's fairness and diversification. And I think that's where we are today. Different challenges. I think the main challenge that has stayed the same throughout the last nine and a half years of our existence has been education and how can we rely on consultants and the advisor community to reach out to learn more themselves, but also feel more comfortable when they're talking to a plan sponsor about adding alts, whether it's as an option, a new option, whether it's within a target date fund structure, or a target risk or a balanced fund, and even managed accounts, which I think we're seeing a lot of growth and innovation from a lot of the Alts firms that are really taking the initiative to educate, whether it's through their own platform, whether it's through organizations like a DCALTA or others.
And I think that is just amazing because the Alts firms and the asset management firms, even traditional firms are getting involved with DCALTA and have been educating folks in different capacities for decades. And I think to have all of that thought leadership involved through DCALTA, through the committees, what we do, the end user, who is the participant or a member, if let's say you're in Australia, and we'll touch on that hopefully too, on what they're doing, is who should be educated.
And I think the advisors, kudos to them for stepping up, in my opinion, on what they're doing.
Tony:
And I did want to pick up on one thing that you said, which I think is really important. And I think it was kind of the crux of the original DOL letter that came out, which is, if pension plans were allocating, they're doing so because they realize the better opportunities exist in the private market.
And I think what you mentioned is interesting because I've had this argument when I've met with our regulatory group, as they're speaking to their counterparts in Washington to say, are we disadvantaging individual investors who don't have access to those great tools? And the answer, of course, is yes.
So the question is, how do we get to having them more broadly available? And maybe that's the perfect sort of segue to talk about what's happening in Australia, because maybe that's a litmus test for us.
Jonathan:
I agree, and as an organization, we do believe that alternative investment allocations should be diversified, they should be professionally managed, and they should also be within a multi asset type of framework, right?
So we're not allowing or promoting or saying that participants should invest directly into drawdown funds. What we are saying is that alternatives should receive an allocation within a multi asset fund, like a target date fund or a balanced or managed account. And, if we look, for instance, at Australia, right when DCALTA was being formed, I was looking outside the U.S. at different systems and the superannuation funds had been investing in alternatives for decades. One of the things, and I hear this quite often now with our members, is that they like to say that it's easier and was easier, probably 10 or 15 years ago, for a member in the AU super, one of the super funds, to invest in U.S. private equity funds than it is for our U.S. retirement savers here. So, I say to myself, that is an issue that needs to be solved. And how can we do this? And Australia has consolidated over time because of a lot because of their private markets allocations and driving efficiencies in these large pools of capital.
And that's how we look at things like, let's say from a DCALTA standpoint is how can you manage that pool of capital efficiently, net of fee, net of benchmark return. And what is the risk that you're taking to achieve what you want to achieve? And I think right now where private markets I think there is concentration risk, let's say in some of the index funds that just in large public equities compared to, let's say we're looking at, and this is another stat that I really like to talk about, is that 87 percent of the companies that generate over 100 million in revenue are private. And that to me is scary. That means that only 13 percent is what's being given to participants today in most of the DC system plans. And that's scary. That's where we need to help educate everyone else.
Tony:
I use that number as well. And we talk a lot about the shrinking public universe and the growing private universe. And again, it's really the opportunity set. We think there's a growing opportunity set here and abroad. Why wouldn't we make that available to individual investors? I wanted to come back on one of your comments though, that I think is really important. And that is the structure, the product structure, and we certainly spent a lot of time in this podcast talking about the evolution of products from the original drawdown structure to these new interval tender offer structure, call them evergreen just for simplicity sort of purposes. Is that a structure that is more conducive to allowing these to start to find their way into defined contribution plans, whether it be in a target date fund format or a 401(k) menu?
Jonathan:
I think it's a path. I do. I think it's a path. And we've always, as an organization, we don't opine on which product is better than another product for access. What I am seeing, personally, when I say me, it is me. It's also DCALTA, but we'll separate that. For me, I'm seeing a convergence in the institutional investments in private markets and the retail or high net worth private markets education that's happening. And that's a good thing. It means that the right message, a uniform message is being delivered to investors as individuals, and that'll help translate into education within the 401(k) system, all the way up to the institutional side of large pools of capital, large DC plans, and large DB plans. As far as products, we are seeing a lot of uptake in interval funds. Private Credit, certainly up year to date, has had 47 percent market share of interval funds, just from a strategy standpoint, which I think is key.
That shows the direction of where investors are looking, and again, that could be high net worth on that side of it, but I think it also drives more comfort to the DC side. I think CITs are another avenue for investment. Collective investment trusts are able to invest in these interval funds, and they're certainly more flexible in the strategies that they can hold, and I think that that's where we're seeing a lot of allocations instead of your traditional ‘40 Act mutual funds that are being invested and we're seeing a lot of CITs being used, which is a good thing. So I think product structure is certainly key. That drives a lot of the conversations that we have at DCALTA and some of the principles that we are putting out and currently working on.
Literally just on a call before I got here about the operational side and where do we want to touch on principles? Are we touching on the record keeping side? Do we touch on trust and custody and platforms and the conversation got narrowed down very quickly because of the members that were on this committee and call and the focus should be on the daily environment and how do we best address the daily environment with illiquids whether it's through product whether it's through strategy, et cetera.
Tony:
And it would seem like the evergreen structure, again, interval, tender offers, CIT, whatever sort of underlying vehicle, but something that's more flexible, lower minimums, more available on an ongoing basis would be more conducive for it being in a DC plan. The other comment that you made earlier, I thought was interesting as well, which is how you deal with liquidity either in the structure itself or outside of the structure, which is something that I've been thinking about. Could you in fact have an overlay manager or some sort of structure where you're making those allocation decisions? That would seem to be a way of solving for some of the concerns out there.
Jonathan:
I agree wholeheartedly on that. And I think managed accounts as well. We see a place where personalized target date funds, let's say, is where we're headed through managed accounts, then that's a good thing. And I think we've spent a lot of time at DCALTA seeing what's happening on the retirement income side, which is wonderful. And it means that innovation has taken place. It means that we're gradually offering the end user, which is a participant, a retirement plan participant and saver, the right tools. And that's, that's what all this is about.
Tony:
Well, I certainly feel a lot better about where we are after our discussion. I'm going to challenge you a little bit here. I want you to imagine where we might be five years from now, where we might be five years from now from product availability to the acceptance of alternatives more broadly. What does the underlying composition look like? I mean, do you have any sense? It seems like we're making a lot of progress. Do you know where we might be five years from now or 10 years? I'm not going to hold you to it, by the way, although, although I may invite you back five years from now, if we're close to those projections.
Jonathan:
Well thank you. I hope you do invite me back. I think in five years, we're certainly going to see all of the work over the next five years by institutions and organizations and alts firms and managers educating the community and all stakeholders. And all of that education will certainly provide better access.
And I think the regulatory environment will hopefully lend itself to more favorable outcomes from anything that we can have, whether it's legislative or regulatory to help our cause. But I do think that in five years looking at a rounding error, I think we are going to start to see allocations to private equity, private credit, infrastructure, even hedge funds.
When we look today at, for instance, private real estate, which was really the asset class that has gotten a lot of acceptance and allocations. We're seeing just looking, for instance, at defined contribution plans and large DC plans and sponsors, we're seeing about a 5.2 percent allocation to private real estate.
And when we look at our data, we have a partnership and we get data from some of the larger DB and DC plans, and not only is that allocation, which I feel is right in between the public sector DB allocation and the corporate DB allocation, so it fits right in there. But I was surprised to see that about 15 out of 38 very large custom target date fund DC sponsors allocating to private real estate. That number was very motivating, and if I look five years from now, I would think that an allocation of, let's say, 10 percent to 15 percent spread across different strategies will be a lot more normal in larger portfolios as well as individual portfolios. Again a 33 percent average allocation to public sector DB plans and then we look on our side and it's again a rounding error I think needs to change. But are you holding me to a percentage invested in allocation?
Tony:
No, directionally, I like what I'm hearing. And again, we spend a lot of time looking at data, whether it's family office data or institutional data. I think institutions are typically 30 percent allocation. I can look at CalSTRS, which I think as of the most recent report that I looked at a 15 percent allocation to real estate alone, a bigger allocation to private real estate than to fixed income, which is very telling on where they see the opportunities.
And I'm not suggesting we get there in one fell swoop. I think one of the things we often talk about on this program is the fact that it's going to be a gradual change getting there. So I'm not holding you to it, but I like directionally where you're going, which is, I think we should be looking at those large DB plans as a marker. Whether we get there in five years or 10 years, at least we're progressing in that right direction. It seems to me to be good for the individual investors.
Jonathan:
Exactly. I think as part of the other research, and this may be surprising to some of your listeners, is that when we look at alternatives in DC plans and we look at the public sector, they're different states. So, for instance, a couple of the very large states have allocations to alts and have for the last over 10 years.
And they first started by unitizing their pension plan and then offering that as a DC option within their defined contribution plans for their participants. And that then gradually became an allocation within their target date fund structure. So they first had it as a standalone option. So participants could go into that option and then over time after it had a track record, which is really their DB plan that you're seeing as an allocation or option in the DC, we've seen them structure that pension within a target date fund and barbell it with different strategies based on philosophy.
And I don't want to call out the names of the states that are doing this, but two totally different philosophies on how they actually looked at that DB allocation, the unitized version, put it in their target date fund, and then what were the other strategies that wrapped it? Two completely different philosophies.
But when we delve into that alts allocation within the option itself, there was about a 55 or 56 percent allocation of alternative investments. That is where I would like to see the U.S. retirement saver, eventually.
Tony:
I think we're in alignment on that. I asked you to kind of think about where we're going to be five years, partly because I wanted to have that marker out there. As we sit here today, and not to get into politics, but as we sit here today, we're starting to get a sense of a new administration coming in that at least has indicated they are going to be more pro-business, lighter on regulation. Do you have any sense of what the regulatory landscape may be in moving forward with some of the work that you've been getting out there and started to socialize amongst all of your stakeholders?
Jonathan:
Yeah. It's a great question. And I can tell you that as an organization and leading our collective voice that we are working on meeting with the team that's transitioning as well as the legislative staff and the regulatory folks that actually make decisions. And that's something that we are working with our members on, and we'll lay out a plan of action on how best to approach this. But our ask is very simple. It's just fairness and diversification. We're not out there discussing private equity, let's say, specifically.
What we are promoting is just access to alternative investments, which, yes, private equity, private credit, infrastructure, and commodities. Commodities have been a long staple investment in portfolios. So this is nothing new. It's just, it irks me today. And in that five year, I think I would want to come back and find out if there were any lawsuits to defined contribution plan sponsors for not properly diversifying their menu of options.
Tony:
That will be interesting to see. Jonathan, you have covered so much with us. I'm anticipating some of our members who listen to this on a regular basis are probably wondering two things. One is, where can they get more information? And then two, how can they contribute to the cause? I mean, this is such an important cause for all stakeholders, whether you're an asset manager or you work with a wealth management firm. How do we all help propel this down the road?
Jonathan:
Thank you so much. For that, we have individual members so they can join, they can visit us at www.DCALTA.org. We post all of our research and our papers, some of the proprietary research that we've done as well as joint research papers. They also can see DC ALTS allocations, so if they're interested in looking a little bit deeper into how public and private DC plans are investing and to which alternative investment strategy, they can certainly find that information there as well. They can see who is on our board, the members that are involved, and also pull up even newsletters that discuss some of the committees and how they can get involved with DCALTA and our other membership.
Tony:
Jonathan, thank you so much. I want to just reach out to our members and just remind them that a lot of the topics that we cover on the Alternative Allocations podcast series actually comes from people that I see when I'm traveling out on the road or they reach out to us directly to let us know topics. And this is a topic that has come up continuously in my travels over the last couple of years. And it's something that I definitely wanted to get you on to speak about. Again, I've written about rethinking retirement. I think it’s one of the biggest opportunities for the overall industry is really figuring out this retirement conundrum.
We know what we want. We know we're moving in the right direction, but we're not quite there. So, I think this was incredibly informative for me, hopefully for our members. I'll remind our listeners out there, and we have a growing and loyal group of listeners. If there are topics you'd like to hear, please feel free to reach out to us directly.
If you like this podcast or any of our podcasts, please rate them. Let us know that you like it. It tells us we're working in the right direction and we're identifying the right guests to bring to you. So Jonathan, thank you so much for your terrific insights. I wish you luck on your journey and we will not wait five years to have you back again to revisit all the progress that you and your organization are making.
Jonathan:
Thank you so much for interviewing me and I'd like to tell your listeners that I actually feel like I should be interviewing you and I look forward to your book.
Tony:
Thank you so much. Thank you, Jonathan.
Jonathan:
Take care.
Show V/O:
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