Gold as an alternative asset in defined contribution (DC) investment strategies provides good hedging against market fall and yields strong returns under various market conditions, according to new research.
Pension Policy Institute’s (PPI) latest publication titled ‘What role could alternative assets play in DC investment strategies in the future?’, sponsored by the World Gold Council, looks at DC scheme investment in alternative assets, particularly in light of new opportunities and the possible advantages that could be attained from using these types of assets during periods of economic volatility.
The report highlights that in contrast to the defined benefit (DB) market, where alternative investment has been a part of its investment strategy for a while, DC schemes have historically invested primarily in equities and bonds, so knowledge of the specifics and intricacies of alternative assets is less developed.
Although there isn’t one asset allocation survey that covers the entire market, PPI’s DC Asset Allocation Survey revealed that DC schemes allocate roughly 12 per cent to alternatives, whilst Mercer’s European Asset Allocation Survey found that the allocation is closer to a third.
The report notes that many schemes still struggle with scalability, particularly on the illiquids side. Access to alternative assets at the smaller end of the market remains a problem, despite the DC industry’s overall expansion. But, according to PPI, the largest DC schemes, though lagging behind DB schemes, have access to individualised offerings that enables them to be more agile in regards to alternative investment.
The report found that participating in alternative investments may also be difficult due to a lack of knowledge and understanding, and some schemes may benefit from stricter regulatory guidelines as well as the guidance of external experts.
According to the World Gold Council, gold has historically performed well during times of rising inflation because of its diverse characteristics, making it a ‘clear complement’ to equities, bonds, and diversified portfolios.
Gold differs from other assets in that its negative correlation to equities and other risk assets rises as these assets decline, as opposed to other assets becoming more positively connected as market uncertainty rises.
The Council notes that while members who are just starting their savings journey will likely continue to prioritise growth assets, those who are nearing retirement may need advice on what higher inflation means for their plans because adverse returns can negatively impact member outcomes with little time for recovery.
It suggests that a 5 per cent allocation to gold can offer a more stable income in retirement.
PPI senior policy researcher Lauren Wilkinson says: “Greater engagement with alternative assets could provide DC schemes with enhanced portfolio diversification, which in turn could increase the level of risk mitigation within the investment strategy. This is especially important during periods of economic uncertainty. Many alternative assets have a low correlation with public markets, so are not generally subject to the same market forces, meaning they can provide a hedge against losses experienced during market downturn.”
Wilkinson adds: “Alleviating these challenges to facilitate greater alternative investment will require an industry-wide shift in the way that cost and value are evaluated and communicated with stakeholders. This is a key priority for the Government, with the Value for Money (VfM) consultation ongoing and an overarching aim to shift the discourse away from just low costs and charges towards a greater focus on the quality of service provided and the value added from investments, which may see alternative investments growing among DC schemes.”
World Gold Council asset allocation strategist Jeremy De Pessemier says: “The DC investment landscape is rapidly evolving, and as DC schemes mature and achieve scale; there is likely to be a growing need for diversifying investments away from traditional equities and bonds into alternatives to deliver good outcomes for scheme members.
“In the current context of economic uncertainty and high inflation, we firmly believe gold can be an effective risk mitigation component within DC investment portfolios. There are several advantages to diversifying the sources of safety in portfolios beyond high quality government bonds and the way gold and government bonds perform going forward is likely to be different from one another. That feature, amongst others, should appeal to DC investors when considering gold.”
