When it comes to investing, large endowments have the secret sauce. According to the latest annual NACUBO-Commonfund report, the largest 9 percent of endowments (those over $1 billion) generated 7.2 percent per annum for the last decade, compared to 6 percent for the smaller endowments. A 2012 Vanguard study credits the investment expertise of these behemoths, and their efficient use of alternative investments, for the performance differential.
Denver-based Innovest Portfolio Solutions, a $15 billion investment consulting firm, uses the same rigor in its 401(k) retirement plan offerings. The first step is the “Capital Markets Assumptions Process,” which utilizes a comprehensive top-down and bottom-up approach to estimating the potential five- to 10-year return of the various traditional and alternative asset classes in the firm’s universe. The exercise is performed at least once a year, and potentially more often if there is a market disruption.
From there, Innovest creates portfolios for its client’s 401(k) participants. These portfolios typically consist of 10 to 12 strategies, and are well diversified in terms of market cap and investment style.
“Innovest’s process utilizes actively managed and index products to produce the best risk-adjusted return,” says Peter Mustian, a principal of the firm.
“Historically, the best way to hedge against portfolio volatility has been fixed income,” adds vice president Christian O’Dwyer. “But times have changed. Bonds are very expensive, and as a result we see the need to diversify.”
A good chunk of that money has flowed to alternative investments.
Innovest uses liquid alternatives for 5 percent to 15 percent of it portfolios, depending on target date, with the most recent target dates getting the biggest share. The firm sees alts as a portfolio diversifier, not a return generator, which makes it a good choice for managing sequence of return risk.
“We have used alternative investments for twenty years, but with the advent of liquid alts, we can now utilize these instruments in 401(k) portfolios,” says CEO Richard Todd. The firm tends to use multi-strategy offerings and rarely picks single manager products. Most of the multi-strat mutual funds we use have been running similar portfolios in limited partnerships for 10-15 years, which gives us confidence in their ability to vet their underlying managers.”
According to Todd, about half of Innovest’s business is creating retirement plan portfolios, and they see the area as a growth engine.
“It’s crucial that the process has proper oversight from quality, seasoned consultants,” he says. “We’ve developed an expertise that is getting real traction in the retirement space.”
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.
