Rosalind Evans
Private equity is increasingly incorporated into defined-contribution plans, offering new opportunities but posing significant challenges.
The Growing Trend of Private Equity in Retirement Plans
Private equity’s inclusion in defined-contribution plans is gaining traction as investment advisors seek ways to enhance returns and diversify portfolios. For instance, MissionSquare Funds (formerly Vantagepoint Funds) offers retirement target-date and target-risk funds featuring its Diversifying Strategies Fund.
This fund allocates up to 70% of its assets to private alternative investments, such as private equity, real estate, and private credit. The remaining 30% is invested in liquid stocks and bonds. As of June 30, 2024, the fund has shown a three-year annualized performance of 5.63%, surpassing its benchmark’s 5.38% gain.
MissionSquare’s approach reflects a broader trend of integrating private equity into retirement plans, mainly through target-date strategies. This is a significant shift from traditional investment practices, aiming to leverage private equity’s potential for higher returns and diversification.
Advantages of Private Equity in Defined-Contribution Plans
Incorporating private equity into defined-contribution plans can offer several benefits. MissionSquare argues that private equity can deliver better risk-adjusted returns compared to traditional stocks and bonds while adding diversification to investment portfolios. Given its lower liquidity, the longer time horizon for retirement savings compared to nearer-term investment goals makes private equity a more viable option.
The evolution of retirement plans, with defined-contribution plans becoming more prevalent than traditional pension plans, further underscores the potential value of private equity. The shift suggests that as defined-contribution plans replace pensions, incorporating private equity could benefit plan participants.
Challenges and Concerns
Despite the advantages, notable challenges are associated with integrating private equity into defined-contribution plans. Research by Cerulli highlights that over half of defined-contribution investment-only asset managers currently have no plans to include private alternatives. Concerns about the illiquidity and opaqueness of private equity are significant barriers. These challenges complicate the fiduciary responsibilities under the Employee Retirement Income Security Act (ERISA), making it difficult for plan sponsors to adopt private equity.
Moreover, investment firms face difficulty selecting appropriate private equity funds and navigating legal complexities. The high standards ERISA requires and the risks associated with private equity investments contribute to the hesitancy among many firms.
Insights from Pension Plans
Analyzing historical data from pension plans reveals no universally accepted allocation percentage for private equity. Pension plans show significant variability in their private equity allocations and returns, indicating a lack of consistency in investment strategies. This variability underscores the need for clear guidelines and education for defined-contribution plan participants.
Enhanced data reporting and transparency are essential to improve the integration of private equity into defined-contribution plans. As more data becomes available and successful examples emerge, employers and plan managers will have better tools to manage private equity investments effectively.
The Future of Private Equity in Retirement Plans
Including private equity in defined-contribution plans represents a significant shift in retirement investment strategies. While clear benefits include enhanced returns and diversification, the associated challenges cannot be ignored. Ongoing research and data improvements will address these issues and facilitate broader adoption.
For those interested in exploring how private equity could impact their retirement plans, it is important to stay informed about emerging trends and consult with financial advisors to navigate these complex investments effectively.
