Are TDFs Shorting Retirement Investors?

In the paper, analysts replace portions of the baseline glide path with conservative and moderate allocations of real estate: 5 percent trending to 0 percent at retirement for the conservative model, and 10 percent trending to 5 percent at and through retirement for what the analysts call the moderate allocation model.

Over the long term, hypothetical savers reduced risk on the lower end of the savers' spectrum for modest losses seen with savers with higher account balances.

"Unlike more opportunistic implementations, core real estate is expected to provide lower returns with significantly lower volatility than traditional growth assets," the paper says.

How hedge funds fared

To test hedge funds, the analysts implemented a conservative strategy that starts at 10 percent of the baseline TDF's total allocation and draws down to 5 percent at retirement, and what the analysts call a moderate strategy, which begins with a 20 percent allocation that draws down to 15 percent at retirement. Hedge fund assets are drawn from the baseline TDF's equity and fixed income positions.

Income replacement rates were improved using both the conservative and moderate allocation models across all income levels, but at lower levels than was seen with private equity. Only the returns of "high-skill, high-conviction" hedge fund managers were modeled in order to account for the wide discrepancy between the best-performing and average managers.

What happens when you use all three

To see how a TDF with the full arsenal of alternatives performed, analysts compared the baseline glide path, which begins with 91 percent equity exposure and tapers to 45 percent at retirement, to a glide path that includes private equity, real estate, and hedge funds along the way, that begins with 97 percent of a portfolio committed to return-seeking assets and tapers to 63 percent at retirement.

While the alternative-laden glide path appears riskier, the paper notes that it holds only 33 percent in public equity assets, versus 42 percent in the baseline glide path.

The alternative model resulted in good to exceptional outcomes, based on the modeling in Georgetown and WTW's paper.

In the best-case scenario, a fully diversified TDF generates almost $94,000 in retirement income for every $100,000 in annual income earned before retirement.

By comparison, the baseline TDF approach generates $77,000 in retirement income per $100,000 in annual wages under the best-case scenario.

In the median outcome, a hypothetical saver would have more than $9,000 in retirement income using a fully diversified strategy compared to the baseline strategy. And in the worst-case scenario, weaving alternatives into glide paths improves retirement income by $2,300 annually, from $21,200 in the baseline TDF strategy to $23,500 in the diversified strategy, assuming the paper's modeling.

"The increased diversification provides risk benefits over time versus the baseline," claim the paper's authors. "While diversification is utilized marginally in the products offered today, there is still a lot of room to enhance DC participant outcomes through greater usage of alternative investments."