Investing in private equity can boost retirement savings accounts

Ministry of Labor last year paving stone way for plan sponsors to add private equity (PE) investments as part of a professionally managed asset allocation fund offered as an investment option to participants participation in defined contribution plans.

And a new report can become a reality — not just on paper but in practice.

Researchers at the Urban Institute find that average retirement savings will increase when 401(k) plans include PE investments held in professionally managed asset allocation funds — such as target date funds or target risk fund – as PE funds earn on average higher returns than public stocks and PEs provide diversification opportunities.

In fact, the researchers estimate – under a most optimistic scenario – that PE investments can increase average account balances by nearly 10% over an entire career. To be fair, simulated impacts vary widely, with some savers substantially better than average and others doing significantly worse, the Urban Institute reports.

And the authors of the report, sponsored by the American Council on Investment, a lobbying, advocacy and research organization founded by a consortium of private equity firms, say that The increase in retirement savings won’t happen overnight.

In fact, they say it will take time to accumulate any changes in returns, so these effects on retirement savings will be negligible over the next decade, when target-date funds are aim to gradually add PE to their portfolio.

“Gradually” might be an understatement. Currently, very few sponsors and plan providers have the opportunity to add PE investments to their services, according to Mike Kane, chief executive officer of Plan Sponsor Consultants. “We only see one or two inquiries about them, periodically, from investment committees,” he said. “We are also not aware of any target-date investment groups that might include PE investments in their asset allocation for various classes.”

Choose the right PE fund

Professionally managed asset allocation funds, such as target-date funds, invest in a mix of stocks and bonds. For example, more than 51% of Fidelity’s Freedom 2050 fund (FFFHX) is invested in US equities, more than 41% in non-US equities and about 7% in bonds. If and when fund companies start investing in PE inside asset allocation funds, the percentage allocated is likely to be small, say, less than 5%.

Tony Davidow, author of Goal-based investing, is generally optimistic about the concept of adding PE to the asset allocation funds offered in 401(k) plans but he said it has to be done the right way.

Among the positives, Davidow said adding PE to target-date funds provides retirees with access to an “elusive” asset class. Typically, PE investments are only for accredited investor Those who understand they are buying an illiquid asset are typically held for more than 10 years.

And because of that illiquidity, PE investments – as the Urban Institute noted – are expected to earn higher returns than public stocks. Other organizations say the same. For example, JP Morgan is telling investors to look beyond the traditional asset markets for higher returns. Its newest The reportJP Morgan expects a 60/40 portfolio to earn only 4.3% annually over the next 10-15 years compared with 8.10% per year for private equity.

However, there is a large dispersion of returns when it comes to PE investments, Davidow said. And there can be a big difference between the best, worst and average returns.

“While private equity has previously provided a substantial illiquidity offset — the excess returns received for capital fixation over a long period of time, but not all,” says Davidow. private equity funds are all created equal,” Davidow said. “In fact, one of the most important issues to focus on is choosing the right fund, because the dispersion of returns from the top performing private equity fund is around 2,000 basis points. In contrast, the top-to-bottom dispersion of returns from the global equity fund is less than 400 basis points.”

Therefore, there is a real premium to choosing the right private equity fund, he said.

Fund structure review

Plan participants also need to consider PE’s fund structure. Davidow says the main fund structures for accredited investors are interval funds or bid funds. “While they offer better liquidity than traditional funds structured as qualified limited partnerships, buyer funds (QPs), they should be considered long-term investments, to allow managers more time to execute their strategy,” he said. “To allow more flexibility for investors in varying their investment options to include private equity, a new product structure or a more improved structure may be required, to accommodate more suitable for the target date fund.”

These new product structures may also have different fee structures, says Davidow.

Previously, PE investors paid a hefty 2% management fee as well as 20% of the profits. But Davidow thinks PE fees will need to fall for 401(k) funds, a trend already being followed with registered funds (duration and tender offering funds).

Does adding PE really increase profits?

Meanwhile, other experts say adding PE investments to the fund on the target date can reduce risk and volatility but may not promote returns as much. That’s because only a small percentage of assets are likely to be allocated to PE investments in a target date fund, said Bryan Hodgens, a retirement professional. “Is juice worth squeezing?” he asks.

That is a question that will likely be debated in the years to come. In a scenario using the most favorable assumptions, the authors of the Urban Institute report said that adding PE to the fund on the target date would increase the average account balance at age 65 to $39,500 dollars (in 2020 dollars adjusted for inflation), or 9.5%, relative to the baseline excluding PE investments from the retirement plan account.

In contrast, the scenario with the least favorable assumptions would reduce the average account balance at age 65 to $3,500, or 0.9% of the baseline. And the scenario, with more neutral assumptions, would increase the average account balance at age 65 to $27,600, or 6.6%.

Hodgens also argues that plans that fund PE investments will have difficulty educating plan participants. “Private funds are not easy to understand, can lack liquidity, and pricing the underlying investments can be difficult,” he said.

Your to-do list

So, what is a 401(k) plan participant supposed to do?

Two items on the to-do list.

One, be wary. If you invest in an asset allocation/target date fund inside a 401(k) fund, don’t ignore notices from your 401(k) plan reporting changes in your fund composition. Read them. It would be easy to miss an up-to-date report that your fund is currently investing in PE.

Two, take the time to learn more about the benefits of diversification. In essence, the act of allocating your investable funds across different assets reduces the overall volatility (i.e. risk) in your portfolio. Gary Sanger, a professor at Louisiana State University. And that’s a good thing.

https://www.marketwatch.com/story/investing-in-private-equity-could-boost-retirement-savings-accounts-11637210606?rss=1&siteid=rss Investing in private equity can boost retirement savings accounts

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