If DC plans make small allocations to private markets in their target-date funds, they are likely to see improved net risk-adjusted returns, according to new research by the CFA Institute’s Research & Policy Center. In a September report titled Private Markets in Retirement Plans, CFA Institute researchers show that as TDF investments get more conservative in the decade before their target date, a modest allocation to private markets can help deliver higher returns without taking on outsized risks.
However, the differences in returns and volatility depend largely on which private market assets the TDF targets. Allocations to private equity and venture capital can deliver the greatest upside, the researchers found. Meanwhile, allocations to private debt, infrastructure and real estate can reduce volatility, but their returns tend to be below those of TDFs with no private-market allocations.
The research comes as the Trump Administration continues its efforts to make it easier for DC plans to incorporate private market investments. In March, the Department of Labor proposed a new rule to help fiduciaries allocate 401(k) plan money to private markets while mitigating potential litigation risks. As a result of these efforts, a growing number of DC plans have announced partnerships with alternative asset managers to develop CITs that would incorporate private assets, often using TDFs. These have included national insurance brokerage OneDigital, TDF fund manager AllianceBernstein and the asset management business of Voya Financial. Consulting firm Deloitte estimates that, under a favorable scenario, private market assets in DC plans could reach $1 trillion by 2030
To assess how private market allocations could impact the performance of TDFs in DC plans, CFA Institute researchers looked at a hypothetical DC plan with a monthly cash contribution by the client that’s invested into a TDF with a 40-year span. They then used a Monte Carlo simulation framework to determine how different investment approaches—one with no private market allocations and others with varying combinations of private market allocations—would affect the amount of money the client would accumulate by retirement.
The researchers assumed a 10% private-market allocation within the TDF, a $25,000 starting salary, a 2.5% annual salary increase, and a 10% monthly contribution to the DC plan. They used PitchBook private market indices to replicate private asset-class performance, the Vanguard Total World Stock ETF to replicate equity performance and the iShares Global Government Bond ETF to replicate bond performance. Their synthetic TDF model featured quarterly rebalancing and a glide path that gradually shifted the portfolio from an overweight in equities to an overweight in bonds.
The results showed that a baseline TDF with no allocations to private markets delivered an end accumulation value of $1.3 million and a mean annual Sharpe ratio of 0.46. A TDF with an allocation to private equity delivered $1.5 million in end value and an annual Sharpe ratio of 0.53, while one with a venture capital allocation delivered $1.4 million in end value and a Sharpe ratio of 0.49. At the same time, end accumulation values for TDFs with allocations to private credit, infrastructure and real estate all trended slightly lower than that of the baseline TDF. These ranged from $1.3 million for private credit to $1.3 million for real estate. All three assets’ mean annual Sharpe ratios came in above 0.5.
“It is notable that the mean annual Sharpe ratio is higher for all TDFs that incorporate private markets than for the baseline TDF, illustrating the risk-adjusted return benefits from the inclusion of private markets,” the researchers wrote.
Importantly, the authors also found that the last 10 years of a TDF portfolio’s lifecycle constituted the critical period when private market allocations had the greatest impact. Over the first 30 years of the fund’s life, private market allocations made virtually no difference in returns compared to a baseline portfolio. However, as the baseline TDF entered its last 10 years and was rebalanced, with bonds gradually replacing stocks as the main holding, returns trended lower. That’s when a 10% private-market allocation helped provide more opportunities for return growth.
The report also examined how splitting the 10% private-market allocation between two asset classes affected the TDF’s performance. A combination of 5% private equity and 5% real estate delivered the highest end accumulation value, at $1.39 million, and the highest mean annual Sharpe ratio at 0.52. A combination of 5% venture capital and 5% infrastructure delivered the lowest end accumulation value, at $1.32, and a mean annual Sharpe ratio of 0.5. Both values were still above those of the baseline TDF.
These results suggest that “plan sponsors should clearly communicate to investors the risk-reducing or return-enhancing nature of the various combinations of private assets in a given TDF product, so that investors can make informed product choices that are suitable to their risk tolerance and return expectations,” the researchers wrote.
They also emphasized how critical the timing of private market allocations is in predicting their potential impact on TDF performance. The “glide-path design—particularly the time horizon of accumulation and the equity-to-bond transition period—can have a larger impact on retirement outcomes than the private market allocation itself.”