RobertPowell

If you’re looking to improve the risk-adjusted performance of your retirement portfolio then maybe it’s time you invested your money like defined-benefit plan managers.

That’s right. Instead of investing in traditional asset classes, a new white paper suggests that you can boost returns, reduce volatility, and beat inflation by investing—if your 401(k) or 403(b) plan offers such options—in real assets, emerging market equities and debt and liquid alternatives.

“Traditional (defined-contribution) plans do not provide the level of diversification and risk balance that plan participants require to achieve their retirement goals,” Robert Capone, executive vice president, BNY Mellon Retirement Group, and the author of the report, said in a related news release.

Terrence Horan/MarketWatch

In fact, the BNY Mellon report attributes “the limited range of investment options included in plans as the primary reason for their inability to match the performance of defined-benefit (DB) plans. DB plans tend to incorporate a range of nontraditional assets.” A recent study from Towers Watson noted that defined benefit plans have outperformed defined contribution plans routinely over the 12 years.

According to BNY Mellon, if defined-contribution (DC) plans were constructed more like DB plans, about 20% of the DC plan assets would be allocated to nontraditional strategies such as real assets, total emerging markets (which combine equities and fixed income) and liquid alternatives.

“Equities comprise a higher percentage of the DC portfolios than they do of DB portfolios,” Capone said. “We believe that applying the best DB practices to DC plans would reduce equity risk and home country bias as well as thoughtfully incorporating alternative investments to increase diversification, return potential and downside risk management.”

For the record, on average, at year-end 2011, 61% of 401(k) participants’ assets was invested in equity securities through equity funds, the equity portion of balanced funds, and company stock, according to an Employee Benefit Research Institute report. Thirty-four percent was in fixed-income securities such as stable-value investments and bond and money funds.

By contrast, in March 2012, 29.8% of the average large defined-benefit plan was invested in U.S. equity, 17.6% in international equity, 30.3% in U.S. fixed-income, 2% in international fixed income, 3.2% in cash, 4.5% in real estate, and 10.2% in alternatives, according to Asset Allocation Trends for Defined Plans. Read that report.

BNY Mellon said “combining emerging markets equity and fixed income would provide a more blended and balanced approach than allocating only to emerging markets equities. The more balanced approach has the potential to reduce portfolio volatility and diversify country and currency risks than could be accomplished with only emerging markets equities.”

The more diversification the better

What to make of BNY Mellon’s report? Should you invest your 401(k) more like a defined-benefit plan?

For the most part, advisers say yes. “For sure,” said Craig Israelsen, a professor at Brigham Young University. “More diversification is better than less—during the pre-retirement accumulation years as well as during the postretirement distribution years.”

Prudent investments

Others share this point of view, though from a slightly different perspective.