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 Pat Arey of Empower. Pat, you guys are making a lot of headlines, really changing the way that people think about allocating to private markets in DC plans. Thanks for joining us.
Patrick:
No, thank you very much. We're very excited to be here. It's been a really exciting last couple of years in the industry and seeing this really kind of grow and come to fruition, and particularly a lot of what's been going on more recently, particularly out of Washington and some of the other innovation that we're seeing from the partners that we're working for on our platform.
Tony:
Very exciting. Maybe we'll start with the basics, though. Talk a little bit about Empower and your role in Empower, and then maybe we'll get into more of the specifics about how you're starting to introduce this.
Patrick:
Absolutely. Empower is an industry leader in the retirement plan space. We're really focused on and known for innovation, working very closely with our customers, clients, as well as our culture. That is to the tune of about $1.7 trillion assets on the platform and 19 million plus working Americans.
My role at Empower, I'm part of the custom solutions team, so I get to play a great role part of the distribution team and working with a lot of our intermediary or advisor-based community in some of these custom products that we're offering to the marketplace, and particularly advice.
Tony:
Let us take a little bit of a step back, and you and I were talking beforehand. We certainly know that in the DB space, the defined benefit plan space, private markets and alternatives broadly have been available for decades and decades and have been significant allocations in especially those larger plans, but it's been a little slower in the DC space. Why has that been?
Patrick:
I think there's a couple of factors influencing that. One is the DB space has been around for a long time. We could either go back to Rome or the 1800s when American Express launched their first DB plan, and it's certainly changed over time based on the needs and their funding status and then how those plans operate.
The DC space relative to the DB space is still quite new, but we have found in recent years that it does tend to reflect some of the trends that you'll see in the pension space and trail it somewhere about five to 10 years, depending on what we're talking about. And it's interesting where DB benefits are great benefits, but they just didn't really prove sustainable for a number of corporations and have certainly phased out.
The DC space wasn't intended to replace that market, but it certainly has, and what we're finding is that participants really benefit from a combination of both the investment strategies and methodologies that we see present in the pension space, like we discussed, the benefits that you can get from private market strategies, as well as some of the benefits that we see from private wealth management or wealth planning and the behavioral aspects of it, or the basic financial planning and personalization that mass affluent or ultra-high net worth individuals get from working with advisors like that. And what we see now is that the advice is critical to getting participants home and really helping them get to their most dignified retirement.
There are also other pieces to the puzzle that have persisted to get us to this spot. I don't know if you remember your first DC plan, but I was really thinking about mine before joining you, and it was hundreds of mutual funds to choose from, and this is early 2000s and in 2006, we saw the Pension Protection Act, which really put more stability and certainty around the default, the QDIA as well as target dates and managed accounts or advice tools are playing a more prominent role there. And then in 2008, we really saw the rise of the independent fiduciary, whether that's a consultant, an advisor or an independent fiduciary, and they really were bringing some of their best practices from working with their clients and other businesses to the DC space. Cleaning up lineups, really kind of aligning share classes, asset classes, and making those available to participants.
And it wasn't until most recently that we started to see more attention on private markets or extended asset classes to be made available. And I also think that some of the regulation that we're seeing and what we're getting out of Washington and some of the DOL guidance proceeding the most recent executive order, has certainly been helpful and motivating firms to take a harder look at that. And we were certainly very forward-looking and understanding that all asset classes should be made available to participants and plans and participants have a right to benefit from those type of investments that are being made available to other similar structures that they may not actually have access to through their current plan sponsor.
When you put all of that together, which is quite a bit, you kind of have a little bit longer of a runway to kind of getting us to the point where we're at now, but we're at a really exciting point where these private market strategies are becoming far more accessible through partners like Empower, who really embrace this. And the real focus is around advice and professionally managed solutions.
So without some of the legislation in 2006, the Pension Protection Act, without some of the recent attention, and without an independent third party fiduciary with a sound process to monitor those investments in the lineup and help with those professionally managed solutions, you really weren't at a place where it could be viable for the masses, which is 14 trillion in plan assets and significant amount of plan participants that need that help.
Tony:
There's a lot to unpack there. You just gave us a history lesson, some of which I remember as you and I were talking about beforehand as a former institutional consultant, I remember how the industry really changed from the DB space being the dominant platform to DC. And I love the fact that you kind of repeated that whole lesson of education being key 'cause I think you're right with the private markets, they are different. They do require more education. We want to make sure that people understand what they're getting into, want to make sure they understand that these are by and large illiquid investments. That's just a feature, not necessarily inherent, good or bad, although the good that comes with that is that illiquidity premium or that excess return that you get over the long run. But I do think that as we start to think about it in the DC place, it definitely fits better in some sort of a managed solution versus just putting 'em on a menu and hoping that individual investors are gonna make the right selection at the right time for the right reason.
So it seems like that would be the preferred path, and maybe as people get more comfortable with it and they have better experiences, then it would make sense in more of a 401(k) sort of menu.
Patrick:
Generally speaking, even when you think in a menu construct, the masses or the mass allocations of participants are centered around professionally managed, or more “do it for me" solutions. And most participants really benefit from advice and having that be done for them. So when we think about asset allocating and making investments in asset classes like private markets, having that be part of the professionally managed solution is important, and particularly an advice-based solution where it's able to really personalize based on the participants you need. And then again, having that additional oversight by fiduciaries in the process and evaluating these and understanding for those that might not have the wherewithal of truly what that illiquid asset means, how that fits into a broader structure that’s again, a professionally managed product for them to really help them meet their retirement need. Which again, similar to the DB space, you're talking about a really long runway for participants reaching their retirement liability. I mean, anywhere from right around 40 years is a pretty accurate number of how long people have to save and retire.
Tony:
You made the comment, Empower has clearly been at the forefront. And you have been pushing the envelope and getting comfortable with allocating to private markets, partly because I think you've looked at the data and you understand how that could be beneficial to retirees and the participants and all of that.
But as you went through that exercise and you thought about how to best bring this to the marketplace, you did focus in on what you thought was the optimal structure. So structures are one of the challenging things that I think has been one of the impediments and maybe moving forward, typically, private markets aren't available in mutual fund structures.
There's hybrid structures, evergreen structures available in the marketplace, but I think you and your firm gravitated towards the collective investment trust structure. Maybe talk to some of the folks who maybe aren't familiar with some of the structural trade-offs. Why did you think that was the optimal structure and what does it afford you?
Patrick:
We at Empower, really believe in plan sponsors and their participants having the right of choice in the asset classes that are appropriate based on their fiduciary’s recommendations and process. And part of that, where we were before, is starting at that overall professionally managed solution. But then there is the operational feasibility of that, and that really starts to come into play with the vehicle choice. To your point, mutual funds are still a very big presence in the DC marketplace. They'll still be there, but we have seen tremendous movement towards collective investment trusts or CIT’s, which from a vehicle standpoint actually predates the mutual fund structure of the 1940 structure.
What's old is new again and serves many purposes. So we see a lot of plans that have been moving there in droves for low-cost investment options. But now when we're talking about products like private markets and how they fit into some of the professionally managed solutions like advice, these are being used to satisfy a couple of things.
One, qualified investor, so the CIT is really filling that role. Two, liquidity. So when we talk about private markets, and to your point, these are illiquid or semi-liquid structures. We need to ensure that participants are able to get their assets on a daily basis, and plans are able to do transactions and movements that plans need to do as part of their going business.
So it's important that we have this wrapper around some of these private holdings and have that be a source of liquidity and structure to make this work in the DC plan. A lot of the firms that we're working with, and again, we're a recordkeeper. We're overseeing the plan and the plan assets and movements.
We're big supporters of advice and our advice products. And as a subset of that, the plans that we work with and the fiduciaries that support and provide guidance to them are using these investments in the plan. So, for us, it's important to ensure that the trust companies that they're working with are understanding and have experience working with these investments. That the underlying private strategies understand the DC marketplace and have some semblance of understanding of the way in which a DC participant acts and behaves. And I think what's been really helpful there, and particularly when we're talking about the trends to get here, is some of these evergreen structures that have been used extensively in the wealth book of business have started to paint a picture of how these work more for all advisors and fiduciaries, particularly in dealing with an individual beyond an institution like a pension.
That piece that I was mentioning before that is really critical is that liquidity, both for the plan itself and the participant and the CIT structure is conducive to satisfying both of those needs from what we've seen and the way in which our partners are working with these solutions that are being used as part of our advice tool.
Tony:
And you've used the term fiduciary multiple times. And I think that's one of the big issues as I understand it from the regulator's perspective, is they wanted to make sure that somebody informed was making decisions which would be in the best interest of the individual investors. I think, as you know, we had Jonathan Epstein from DCALTA on the call, and he turned that fiduciary discussion a little upside down to say, wouldn't it be a disservice to not provide access to these great investments to individual investors. And I love the way he framed that discussion. But how did you get comfortable with this whole notion of fiduciary and understanding the providers that you're working with? And again, there's multiple levels of fiduciary. One is the fiduciary responsibility in picking and selecting the right investments. And then the other is making sure that this is actually in the client's best interest. How did you guys grapple with all of that?
Patrick:
A big part of our business and our model is working directly with intermediaries, so advisors, consultants, third party fiduciaries, and we know much of the market very well, and they do a tremendous amount of business on our platform.
Over time, their models have changed quite a bit as well. Everything from moving more from a 3(21) role into a 3(38) role where they're taking on greater investment selection, responsibility, and fiduciary oversight, as well as to building custom products, which started with custom target dates, have evolved into a subset of managed accounts or advice products called Advisor Managed Accounts, where they're taking some of their best practices that they use with their clients today and putting them in a product that, again, is based on their own intellectual capital and how they want to see personalized investments be managed through an advice engine. There's been a lot of experience in working with them, and as a result of that, many of these firms have experience working in the private wealth space. So a lot of advisors that we work with today have significant, if not equally sized wealth practices and a number of the evergreen structures in the private markets have served their private wealth clients very well. And they too very much wanted to see private markets be treated as an equal asset class to all of those other asset classes that they've been working with with their DC client base.
We also see in the consultant driven market, very similar trends, just slightly different, where those consultants are also working with major pensions, endowments, foundations, sovereign wealth funds. And it's the same scenario that there's a want to see more equality or the right for plans and the DC space and their participants to have access to the same asset classes that some of their other clients do. Having worked with these firms and again, knowing them quite well, it wasn't a stretch for us to be seeing them immediately starting to act and underwrite some of these strategies and understand how they could start to use them through professionally managed products on our platform. Particularly with those who are operating advisor managed accounts on our platform today.
Tony:
It's just fascinating how this has all come together, and you've mentioned a couple times that natural sort of intersection between what's happening in the wealth channel versus what's happening in the individual retirement space just because the end user is often the same.
Certainly our focus with the Alternative Allocations podcast and all of the work that I'm responsible for creating, whether it's white papers, blogs, podcasts, or my recent book is really to help advisors and investors better understand how to use these versatile and valuable tools. I wanted to maybe just ask you, how do you think the advisor fits into this equation?
Because I think that as much as we can from a headquarter perspective, I think as you point out, that advisor often has the relationship with the individual who has both feet in the door. They have a relationship in the wealth channel, and they also have a DC relationship there. How are they pivotal in providing that advice that furthers this discussion?
Patrick:
They're a critical piece to the puzzle, both in terms of the process in evaluating and offering some of these products, as well as partnering with us as a record keeper and ensuring that education is done in an appropriate way to both. The plan level and the participant level so that you know not only a committee, but also the participants understand what they're in and that they have ongoing support, not just in the private market investment itself, but their overall investment strategy and what's actually happening for their overall retirement.
We recently did a survey of advisors and we found that 68% of the advisors that we work with today are using private market strategies predominantly in the wealth space, and nearly 60%, 58%, of those advisors would feel comfortable with recommending private markets to retirement plans. Interestingly enough, if those advisors also were working with a pension, that number jumps up to 75%.
Those advisors are in fact doing a tremendous amount for the clients they're working with and really see that value and having private markets be looked at as an equal asset class available in the DC space. Those advisors themselves, if we really wanna kind of get more specific in how they're working on our platform and with some of these products. Within our advisor, managed account, client base, these advisors again have experience with having their own custom advice product to which they control the asset allocation and the underlying models. That gives them greater latitude and understanding what the base investment allocations and investments will be, and then that's using an advice engine to personalize glide paths and bring basic financial planning to participants.
So a very holistic way to deliver a retirement plan on an individual basis. It also feels very similar to what they would do for a very wealthy client on the high net worth side and how they would offer them more white glove treatment and understanding exactly what their need is. Not to call it one of your books, but more goals-based investing in the wealth channel to help them understand how they should be specifically, but to be able to do it systematically for the masses in that giant $14 trillion space.
And many of these books of business for these advisors or these independent RIAs is quite large. They have the ability to really deliver that asset allocation and that normalized private market exposure in an appropriate way through their processes and a product that they're responsible for overseeing on the platform.
Tony:
It's such an exciting time. I want to go back, you mentioned $14 trillion. What do we think the size of the opportunity? We spent a lot of time thinking about the size of the opportunity of private markets and the wealth channel. But the retirement opportunity is enormous. What do we think collectively that opportunity set is?
Patrick:
I think, longer term, again, as this starts to continue, generally when you think about extended asset classes in the DC space, whether it was real assets, REITs, commodities, just some of these more, I guess nuanced asset classes that are public and made their way into professionally managed products, whether that be advice or target dates.
They typically started somewhere in like the small single digit to double digit. But when we think about private markets and just some of the dynamics and way the investible universe has changed, I think you'll see those start to be used to a more significant extent. The longer you go, it's hard to really put a finger on or speculate to exactly what that will be.
I think there's some pretty significant guidance out there today that speaks to 15%. Generally, what we're seeing in some of these products that are going live, or both in use on our platform or other places is somewhere in that 10 to 15% range. But when you look at other guideposts, whether it's superannuation in Australia, some of the bigger pension systems here, that number could certainly grow either exponentially, but I do think it will grow progressively as firms continue to get comfortable with exactly how the structure is working in the professionally managed solutions in these retirement plans. So not a really direct answer to what you're saying, but I'm not really one to speculate on an exact number of where it'll end up.
Tony:
That's helpful. We think of a similar sort of journey when we look at the Wealth Channel. The Wealth channel has historically been about five to 6% allocated to alternatives broadly, and probably three to 4% in the private markets area. So, we talk about a journey where we eventually get to a 15 to 20% allocation because it starts to change the outcome for individual clients, but we understand it's not going to be in one fell swoop.
It's going to be a gradual process where hopefully we're educating advisors and investors along the way. They're having those good outcomes, they feel more comfortable in allocating capital, and then they start to feel comfortable increasing that allocation gradually over time. But this has been fantastic. You've shared a wealth of information for all of us, and it's a really exciting opportunity as we think of the opportunities in the retirement space and the wealth channel and that natural sort of intersection.
Patrick:
Really appreciate you having me and would agree this is a really good thing for the DC space. I think the current state of it and where we're at, the advisors and the consultants that are working to bring the solutions that they've worked very well with DB plans and their high net worth clients is a great addition to help their DC plans and participants experience the same access and have the same ability to have these be used as professionally managed solutions to guide them through their retirement and help get them to their most dignified retirement. And it's all about overall participant outcomes and getting them there.
I also think that normalizing access to private market investments in the same way that all asset classes are made available are a key part of these solutions that our advisor partners are bringing to the retirement plans and thus participants. And at the end of the day, it's all about taking participants through their retirement and getting them to their most dignified outcome. Without private markets, there is certainly a missing puzzle piece to opening up the full investible universe to a participant. As we know, markets have changed quite a bit over the last 20 years, and there are certain benefits to diversification and results that these private market investments can bring to a participant, particularly done in a professionally managed way through a very strong process that's overseen by a known fiduciary to the plan.
Tony:
Very exciting time for both the wealth and the retirement channel. Pat, thank you so much for joining us here. I think we share the common view that these incredibly versatile and valuable tools can help fulfill individual investors' goals, dreams, and aspiration.
We'll have to have you back to revisit this topic as we start to see progress along this journey. Thank you so much.
Patrick:
Thank you so much, Tony. Really appreciate it.
