Private equity and private credit may improve returns of 401(k) plans in the long term, if done right, recent studies have shown. However, it may not be as much as plan participants hope. The assets have long been out of reach for individual investors but are becoming more accessible as new products come to market. In August, President Donald Trump signed an executive order to “democratize” access to alternative assets, such as private credit, private equity and cryptocurrencies, for 401(k) and other defined-contribution plans. The order directs the Secretary of Labor to reexamine fiduciary guidance on the investments in such plans, which are governed by the Employee Retirement Income Security Act of 1974, or ERISA. While some have said the inclusion of private assets could strengthen portfolios, two recent analyses found there are caveats to that thesis. Vanguard found that, using highly-skilled managers over the course of 40 years, a 10% to 20% allocation to private assets within a target-date fund could boost retirement wealth by 7% to 22% and retirement income by 5% to 15%, after fees. That long-term horizon matters since there is much greater dispersion within the returns of private assets than passive target-date funds, said Fiona Greig, global head of policy and research in Vanguard’s Investment Strategy Group. In other words, investors have to be able to stomach periods of underperformance, she said. Yet, the median holding period for a target date fund within 401(k)s managed by Vanguard is four years. As investors switch jobs, they sell one fund and buy another within their new 401(k). If the public market is down when they sell, they’ll still buy at those lower levels. The same is not necessarily true for private assets, Greig told CNBC. “I’m in this plan and I have to sell my assets because I’m switching jobs. When I get to the next plan, I cannot presume that I would have access to that same stack of private assets that I had to sell when they were low, or that I would have access to private assets at all,” she explained. A separate analysis by Morningstar found that an allocation to private credit and/or private equity can lead to an increase of 1% to 17% in sustainable spending throughout retirement, depending on the investor, amount allocated to privates and the overall portfolio size. Notably, the analysis did not find any downside by adding allocations to privates. The firm modeled the investments in semi-liquid evergreen funds, which don’t have a fixed end date and include a liquidity sleeve to allow for redemptions, investments and periodic rebalancing. However, it’s a new area of the market, so there isn’t a deep history to study, said Hal Rattner, head of research for Morningstar Investment Management. “Any decision to add private markets is really a function of, I’d say, a combination of the lack of much history here and the fact that so much is dependent on the … combination of: What are the products on offer? What does the participant population look like? … What are the other offerings in the plan as well?” he said. His findings also didn’t include assumptions about any secondary fees involved, which could impact performance. “What the fees ultimately look like are going to have a big determinant on whether it’s actually going to add value or not, and the fee environment is still evolving,” Rattner noted. A measured approach Adding private assets to defined contribution plans is more of a “want” than a “must-have,” since traditional 401(k)s have come a long way and can deliver effective returns to participants, said Jared Gross, head of institutional portfolio strategy at JPMorgan. He recently released a report for the firm delving into the role of privates in the plans. His thesis is that while the alternative assets can expand the opportunity set for investors, a measured approach is required. That includes active management, transparency and liquidity. Plus, plan sponsors must demonstrate they are acting in the best interest of participants, he noted. “The bar is high, but it can absolutely be cleared if plan sponsors essentially seek out good advice and choose partners who have the experience to do this,” Gross said. Cases in point JPMorgan is among those that already have experience in the area. For 20 years, the firm has offered a daily-valued direct real estate strategy to defined contribution plans. It is a sleeve of a target-date fund that has a private fund structure, as well as some public real-estate assets for liquidity, Gross said. The result has been better risk-adjusted returns over long horizons than a public-market only strategy, he said. “Some of that comes from a reduction in volatility. Some of that comes from an improvement in performance,” said Gross, noting that there are periods of times when public assets outperform real estate and other times when they underperform. “On balance, real estate produces attractive returns, on par or slightly ahead of public markets, but it also reduces volatility, both through diversification and the low volatility of the assets themselves.” AllianceBernstein also has allocations to private assets through its custom target-date funds. The custom funds have global assets of $105 billion under management. About 25% of their custom target-date clients are already allocated to privates. For defined contribution plans, like 401(k)s, the assets are housed in a collective investment trust (CIT) so there is daily valuation and liquidity, said Christopher Nikolich, head of glide path strategies in AllianceBernstein’s multi-asset solutions business. The CIT is used alongside traditional public equities and fixed income within the target-date fund. When determining allocations, he looks at what he’s trying to deliver for participants, whether they are young, in mid-life or at or near or in retirement. “If I think about those three broad segments of someone’s life, I have the opportunity to enhance their returns with private equity. I have the ability to deliver more inflation sensitivity when they really need it with allocating to private real estate or private infrastructure,” Nikolich said. “Private credit allows me to diversify equity risk and also improve the yield or the income that I’m delivering to someone in retirement. So all of those are reasons to do this,” he added.
