Insights

Why DC pension schemes should consider a hedge fund beta allocation in their default?

Defined Contribution (DC) plans in the UK require innovative approaches to counter key risks. Here’s why DC plans need to consider diversifying into alternative asset classes.

06 November 2025

Olivia Kennedy, CFA

Head of European Institutional Strategy

The DC investor universe is constantly evolving to meet members’ retirement goals. Recent volatility in markets (caused by, amongst others, geopolitical events, the COVID-19 pandemic, and more dynamic central bank policy making) has made it even more challenging to deliver efficient investment growth.

DC plans have grown significantly in size since the introduction of auto-enrolment in October 2012 (in 2022, the aggregate value of workplace DC assets was around £545 billion, up from around £324 billion in 2015).¹

As a result of these trends, more UK DC pension schemes are considering an increase in their alternative asset class allocations to diversify a heavily concentrated equities and bonds mix. But adoption has been slow.

We believe that, going forward, further innovation will be needed to better address the key risks to DC plans, such as:

Opportunity cost: Not generating enough investment return, affecting retirement savings
Inflation risk: Protecting the real value of savings
Capital risk: Significant capital losses especially when closer to retirement

There are different estimates currently regarding the use of alternative asset classes. According to Pensions Policy Institute (PPI)’s DC Asset Allocation Survey in 2022, DC schemes allocate around 12% on average to alternatives, while Mercer’s 2021 European Asset Allocation Survey found the allocation to be around a third of the total DC assets, although this includes Multi-Asset/Diversified Growth Strategies too, so the alternative allocation would be less.

Why consider hedge funds in DC pension plans

Hedge funds are now an established asset class as they have been around since the 20th century. They are considered an alternative investment strategy and have the potential to improve DC investment strategies and member outcomes as shown in the analysis below using historical data over the past 25 years:

Improve risk adjusted returns: Potentially higher and/or less volatile returns compared to traditional asset classes that can be found in a DC glidepath.

2. Downside protection: Risk management is a key driver of value delivered by hedge funds—with a focus on capital preservation often a central tenet.

3. Diversification: Enhanced portfolio diversification, which could offer risk mitigation, especially important during periods of economic uncertainty, due to low correlations with traditional assets.

Figure 3: Low correlation to other asset classes

	HFRX Global Hedge Fund Index	MSCI World Index	Bloomberg Global Aggregate	60% Equities / 40% Bonds
HFRX Global Hedge Fund Index	1	-	-	-
MSCI World Index	0.66	1	-	-
Bloomberg Global Aggregate	0.22	0.33	1	-
60% Equities / 40% Bonds	0.64	0.98	0.53	1

Source: FactSet, HFRI and State Street Investment Management. Data is from 01/1998 through 06/2025.

Key challenges for DC pension plans investing in hedge funds

Fees: Hedge funds tend to have high cost structures due to high investment management fees and performance-based fees. DC investors tend to be cost conscious due to the DC Charge Cap of 0.75%.
Liquidity: Active hedge funds are less liquid than traditional assets, including less than daily valuations of assets and lack of immediate (daily) access, which also contributes to the lack of availability from the main DC platform providers.
DC member understanding: Hedge fund strategies are new to DC participants, who may require additional education with a focus on key return drivers, risk drivers, and diversification benefits.

However, academic and practitioner research has shown that hedge fund returns, in aggregate, can be replicated by using market factors, such as interest rates, corporate credit, emerging markets, commodities, and equities. Therefore, hedge fund indices can be replicated by dynamically buying exposures to these same market factors.

So-called hedge fund beta strategies would be relevant for DC pension schemes, as they allow schemes and their members to benefit from some of the advantages that hedge funds as an asset class can offer while avoiding some of the hurdles for DC schemes, such as high fees or illiquidity.

Our State Street Global Alternative Beta Fund

Our State Street Global Alternative Beta Fund is built on the investment thesis that you can replicate hedge fund indices, with minimal tracking error and using liquid instruments, by buying the same factor exposures that underlying hedge funds have and dynamically rebalancing the portfolio in line with hedge fund positioning. This is all whilst being conscious of costs and liquidity to align better with the DC investment design.

We believe the main features of Hedge Fund Beta for DC investors include:

Value for money

A cost-efficient solution to access the advantages that hedge funds, as an asset class, can offer in a cost-efficient manner thereby fitting more easily in DC pension plans’ strategies.

Enhanced diversification

Adding Hedge Fund Beta to a glidepath can further enhance the diversification of the DC strategies, as it offers greater exposure to different sources of return and low correlation with the traditional asset classes of the DC default design such as equities and bonds.

Glidepath protection

At the same time, the enhanced diversification provides key risk benefits in falling market periods such as reducing volatility and mitigating potential draw down risk (capital loss), which is crucial especially during the consolidation and near-retirement stages of the glidepath, enhancing DC members’ outcomes for a more secure retirement.

Passive portfolio-friendly

Many of our DC clients who manage passive-only investment propositions have been unable to integrate hedge fund allocations in their existing defaults. Our Global Alternative Beta Fund allows DC schemes and Master Trusts to get access to the assets class in their passive portfolios.

Governance friendly

Active hedge fund manager research is a resource-intensive and costly exercise, especially in light of ever-increasing demands from investment committee and Trustees. A Hedge Fund Beta allocation, due to its systematic and rules-based investment approach, reduces the burden on investment committees and Trustees for period reviews.

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If you’d like to learn more about our Hedge Fund Beta capabilities or State Street Global Alternative Beta Fund, please contact your sales representative.

Endnote

Disclosure

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The views expressed in this material are the views of the Defined Contribution team through the period ended 10 October 2025 and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.

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Diversification does not ensure a profit or guarantee against loss.

Equity securities may fluctuate in value and can decline significantly in response to the activities of individual companies and general market and economic conditions. Bonds generally present less short-term risk and volatility than stocks, but contain interest rate risk (as interest rates raise, bond prices usually fall); issuer default risk; issuer credit risk; liquidity risk; and inflation risk. These effects are usually pronounced for longer-term securities. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss.

Hedge funds are typically unregulated private investment pools made available to only sophisticated investors who are able to bear the risk of the loss of their entire investment. An investment in a hedge fund should be viewed as illiquid and interests in hedge funds are generally not readily marketable and are generally not transferable. Investors should be prepared to bear the financial risks of an investment in a hedge fund for an indefinite period of time. An investment in a hedge fund is not intended to be a complete investment program, but rather is intended for investment as part of a diversified investment portfolio.

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