Don’t hold your breath for alternative investments, such as private equity or credit, to show up in 401(k) plans. According to the April edition of the Cerulli Edge: U.S. Monthly Product Trends report from consulting firm Cerulli Associates, the higher fees, lower transparency and less-certain outcomes for these asset classes make defined contribution plan managers reluctant to include them.
While corporate pension plans do allocate to alternative investments, reaching 12.4% in 2022, Cerulli analysts noted that defined contribution plans face greater constraints under the Employee Retirement Income Security Act of 1974. ERISA rules don’t explicitly prohibit the use of private funds. However, they emphasize the plan managers’ fiduciary duty to offer the best possible investment options with the lowest possible fees. As a result, private funds’ lack of liquidity, opacity and typically higher fees can open managers to legal liabilities.
When Cerulli asked investment managers who focus only on defined contribution plans if they planned to add private equity to their multi-asset-class products, such as custom target-date funds, in the next 12 months, 46% answered “No.” Twenty-three percent said they would consider it if they were approached by consultants, advisors or plan sponsors. Another 15% said they were still in the “fact-finding” stage for private equity investments. Only 8% said they already include private equity in multi-asset-class products, while another 4% planned to add it in the next 12 months.
The attitude was slightly more open toward private real estate. Nineteen percent of respondents already include it in their multi-asset-class products, while 22% are in the “fact-finding” stage. Forty-one percent said they are not planning to include private real estate in their distribution plans in the next 12 months, and 15% said they would consider it if approached by consultants, advisors or plan sponsors. According to Cerulli, what likely accounts for the difference between DCIOs’ attitude toward private equity and private real estate is that the latter is, by its very nature, a long-term, uncorrelated, largely illiquid asset class.
The survey included 30 asset managers and was conducted by Cerulli in the second quarter of 2023.
Outside of legislative changes to ease the potential pressure of lawsuits plan sponsors might face if private funds underperform, “Defined contribution plans will be able to adapt alts in a significant way if they are able to increase their prevalence in off-the-shelf or custom target date funds,” wrote Adam Barnett, senior analyst, retirement, at Cerulli, in an email. “Secondary to TDFs, greater inclusion in advisor-managed accounts would also lead to significant adaptation to DC plans.”
Alternative asset managers know the challenges they face in getting 401(k) plans to incorporate alternatives. In Cerulli’s survey, they placed defined contribution plans at the very bottom of institutional distribution segments they view as offering the best opportunities for growth in the next 24 months. Of 20 firms that responded, only 15% expressed an interest in 401(k) plans. In contrast, 65% expressed an interest in ultra-high-net-worth investors and family offices, 60% expressed an interest in pension plans, and 25% were interested in fund-of-funds.
“As it stands today, attempting to include alternatives such as venture capital and private credit in DC plans is tantamount to trying to put a square peg in a round hole: it simply does not fit,” Cerulli researchers concluded.