Research

A new report from Georgetown University’s Center for Retirement Initiatives (CRI) and CEM Benchmarking (CEM) finds that adding illiquid assets, such as private equity, real estate, and infrastructure, to the target date funds (TDFs) of defined contribution (DC) retirement plans would have resulted in a 0.15% (15 basis points) increase in return per year over a decade. When applied to all U.S. target date options, such an increase would currently represent $5 billion in additional annual net returns.

Defined benefit plans, endowments, and foundations have long enjoyed the benefits of investing in private real estate, namely diversification, lower volatility of returns, a hedge against inflation, and the potential for improving risk-adjusted investment performance. This paper considers the current inflationary environment, and the impact core private real estate can have, not only in defined contribution (DC) target date portfolios, but also in multi-asset inflation-sensitive options for participants.

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Consistent with our mission of enhancing retirement outcomes, DCALTA has published a practical framework to provide plan sponsors clarity on the implementation of daily valuation of private assets.

We examine the impact of including private investment funds into diversified (e.g., balanced and target date fund) portfolios that otherwise hold only public stocks and bonds. Our analysis utilizes a comprehensive sample of 2,515 U.S. private equity funds to create simulated portfolios for 1987-2017 that invest part of their overall equity allocation in these funds. We find that investing in private funds always increases average portfolio returns and reliably increases Sharpe ratios (return per unit of risk). The results are robust when accounting for the inclusion of higher fees for the private portfolio and while randomly selecting a few funds from each vintage year (e.g., 10), suggesting that the results are feasible in practice for many investor types.

In this article, we propose that in private equity, measurement of asset manager (general partner [GP) skill should begin with a repeatable benchmark-based performance attribution, which is then extended to explicitly quantify sources of alpha. Furthermore, in this article, we lay out a framework for repeatable measurement of performance attribution. Modern proxy benchmarks form a key component of this framework by enabling public market information to systematically inform private equity performance.

Some of the features enabling private markets to generate outsized returns are incompatible with how Defined Contribution ("DC") pension plans operate: for institutions functioning in a daily pricing environment, it can be difficult to invest in asset classes that only provide episodic liquidity. However, as private markets have evolved, new investment structures have emerged which have the potential to resolve this dilemma.

Without long-term returns, schemes do not have an effective way to facilitate good retirement outcomes. And without long-term finance, the economy cannot produce those returns and contribute to wider prosperity.

Taking a theoretical approach, we first examine the effects that an allocation to private markets can have on the risk/return profile of a portfolio consisting of traditional asset classes (Section 1).

We then set out to examine the potential impact a relatively modest allocation to private markets could have on an illustrative DC plan over a long-term time horizon (Section 2).

Lastly, we touch on some of the structural reasons DC plans have historically been unable to invest in private market funds. We argue that most of these obstacles can be overcome today by private market investment managers, enabling DC beneficiaries the flexibility to access private market investments – an accretive portfolio allocation that DB beneficiaries have enjoyed in the past (Section 3).

This publication explores the impact on return potential of Target-Date Funds (TDFs) by changing the asset allocation mix to include assets with higher return potential without increasing the overall risk profile.

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