Keep a steady course, change it up, consider new investment menu options—it’s that time of year again, and what moves, if any, should plan sponsors and participants make heading into 2019?
Real estate is one area to consider; no, not REITs, but direct real estate investments themselves.
The concept is gaining traction in 401ks, driven by two factors, according to Brendan McCarthy, National DCIO Sales Director with Chicago-based Nuveen.
The first is that real estate tends to be an asset class that that end investor better understands. It’s more tangible than other components in the portfolio, McCarthy explained, and most have had some personal experience with investing in real estate, whether it be residential or commercial.
“The second factor we see that’s probably more powerful is that direct real estate is an asset class that has historically only been available to large institutional investors, and now we’re bringing that to the mom-and-pop investor,” he said. “They can access direct real estate through their target date funds and their 401k plan.”
The result?
It’s lifecycle sales through the end of the third quarter are up more than 50 percent over all of 2017. The company attributes much of it to the inclusion of direct real estate in the target date portfolio and the better risk-adjusted returns it can produce for target date fund investors.
The rental income produced can also act as an inflation hedge, something especially relevant for retirees when experiencing inflationary periods.
McCarthy and John Cunniff, lead portfolio manager of the TIAA target date fund series, sat with 401(k) Specialist to discuss the process they employ and the critically important benefits that direct DC real estate investment offers.
Q: Are there specific sectors that are more specifically appropriate for a target date fund, and some that should be avoided at all costs?
Cunniff: Our core strategy is all U.S. properties, and it’s conservative and diversified. It’s office properties, retail, multifamily and also industrial properties.
We’re geographically diversified as well, with properties on the East and West Coasts, the south and middle of the country. That was by design, to have that core strategy, as well as employing some leverage in the portfolio. You need to have leverage with commercial real estate because you’re not only buying the building, you also have to buy the debt that goes with it.
The leverage is modest at 10 percent, where the average core real estate strategy would be higher 30 percent. We asked for that because we’re owning it within a target retirement date strategy offered as a qualified default on 401k plans.
Q: How does it act as an inflation hedge within the portfolio?
Cunniff: We went to Boston and visited one of our properties there. With that particular property, the company that has the lease on that floor, they have an auto-escalation, so they’ll be paying a little bit more each year. We have we have over 500 investment professionals to handle all aspects of real estate.
We have our own portfolio management team for the real estate fund that we invest in, and they have specialists do the research to identify appropriate cities. We also have local acquisitions officers, who we call our “boots on the ground” that live in those cities and are experts on that market.
This is in addition to the asset management professionals that help manage the term of the lease.
When leases are up for renewal, there’s the negotiating with market-based rates, as well as ensuring the needed diversification; you’ll have a tech company on one floor, an architectural firm on another and then maybe a local government office on the other floor.
You have that economic diversification, but you want to stagger the leases as well so that each floor’s lease does not expire the same year.
Q: What separates you from some of the other funds that are out there? What do you do differently?
Cunniff: We’re are the only mutual fund target date provider with real estate, and we needed an SEC exemption for that.
Our firm has extensive, multiple-decades of experience investing in real estate, equities and fixed income and also managing real estate properties in funds that price daily, and they have a whole independent process around that, which is critical.
In our glide path at a high level, our advantages include our overall asset allocation. We have a focus on a human-capital, financial-capital framework, investor simulation, maximizing the outcomes at, and in, retirement.
So [we’re] looking at the problem from an outcomes-based focus, diversification across asset classes—including real estate—and also different approaches to investing within equities, some fundamental and some quantitative.
Our fees are highly competitive, and for our active managed fund where the real estate is owned, the fees are in the bottom quintile. We also have a lifecycle index series which is in the bottom fourth percentile.
With more than 20 years serving financial markets, John Sullivan is the former editor-in-chief of Investment Advisor magazine and retirement editor of ThinkAdvisor.com. Sullivan is also the former editor of Boomer Market Advisor and Bank Advisor magazines, and has a background in the insurance and investment industries in addition to his journalism roots.