A majority of defined contribution investment only (DCIO) asset managers currently have no plans to incorporate private equity in their multi-asset-class products, but that could change, according to recent survey results by Cerulli.
The survey of DCIO asset managers—conducted during June and July after the Department of Labor issued guidance allowing for private equity investments to be incorporated into multi-asset-class strategies (e.g., target-date funds)—found that more than half (58%) say they have no plans to incorporate private equity in their multi-asset-class products over the next two years. Furthermore, 15% say they would consider this if approached by a client or consultant, while another 15% indicate that they are still in the initial fact-finding stage.
These findings are reported in the October 2020 issue of The Cerulli Edge—U.S. Monthly Product Trends.
A June 3 Information Letter by the DOL affirmed that private equity investments as a component of a professionally managed multi-asset-class vehicle structured as a target date, target risk or balanced fund can be offered as an investment option for participants in DC plans under ERISA, including funds that serve as the plan’s qualified default investment alternative (QDIA).
While the use of private equity has never been prohibited under ERISA, Cerulli believes the DOL’s clarifying position will likely encourage broader adoption within DC plans over the long term.
Separately, a 2020 survey of target-date fund managers—conducted prior to the DOL’s information letter—found that no respondents reported allocating to private equity within an off-the-shelf target date series, and only a small minority (8%) planned to incorporate private equity products within the next 12 months.
Cerulli observes that private investments may seem “ill suited” to the DC market, as these strategies are generally more expensive than traditional equity funds, and plan sponsors focus on fees and apply continuous downward pressure on both administrative and fund-specific expenses. In addition, class-action ERISA lawsuits have proliferated over the past decade and plan participants are accustomed to daily pricing and liquidity, while private investments are generally “less nimble” in this regard, the report notes.
What’s more, less than half of asset managers reportedly consider the use of nontraditional asset classes to be “very” or even “somewhat” important. Cerulli notes that, in a conversation with an asset manager, the person commented that, “From our perspective, private equity isn’t a big opportunity in DC… maybe in the DB space where liquidity is less of an issue.”
Return Potential
However, this view is hardly universal within the retirement industry, according to the report. “Some providers note an apparent performance gap between DB and DC plans, opining that with private, illiquid investments comes the potential to deliver superior returns,” it states.
“There is a misperception that by adding private investments in a 401(k), you’re going to get sued, but this DOL letter clarifies that it’s really about due diligence,” according to one asset manager quoted by Cerulli. Still, another target-date manager with allocations to alternative investments explains that the industry is trending toward more liquidity, not less, and emphasizes the importance of offering daily valuations, the report notes.
As such, Cerulli maintains that DC providers “must strike a delicate balance” between bolstering returns and minimizing fees. Moreover, the report suggests that it will likely take time for many DC product providers and fiduciaries to get comfortable with certain illiquid alternatives that are less common within the DC market, such as private equity.
“One thing about the DC market… they might be the slowest to offer something, but then they’re the quickest to mimic,” speculates another research participant quoted in the report.
Meanwhile, the use of real estate as an alternative investment—primarily real estate investment trusts but also private real estate—is more common in target date strategies, the report further notes. Nearly 80% of target date managers allocate to traded real estate investment trusts (REITs) within one of their off-the-shelf series, while 25% currently allocate to private real estate or plan to do so in the coming months.
“The expensiveness and illiquidity of private real estate relative to more traditional asset classes certainly warrants fiduciary consideration, particularly given the looming risk of litigation with the DC market,” the report advises. Cerulli suggests, however, that the DOL’s guidance regarding the use of private equity in multi-asset-class products could serve as a catalyst for other illiquid alternatives as well, including private real estate.
