February 18, 2022

Private Equity Value-Add

Replacing TDF equity allocations may improve readiness.

Reported by Noah Zuss

The simulated swapping of target-date fund equity allocations for private equity investments in defined contribution plans yielded a promising prediction: more participants being able to retire at age 65 and maintain income adequacy, says new research from the Employee Benefit Research Institute.

In his paper “The Impact of Adding Private Equity to 401(k) Plans on Retirement Income Adequacy,” Jack VanDerhei, director of research at EBRI, examined the impact, in three scenarios, of replacing 5%, 10% and 15% TDF equity allocations, respectively, with equivalent allocations to private equity.

… plan sponsors in the U.S. might have concerns about including such investments in their DC plan fund menu.

“We found that every level of private equity modeled resulted in additional 401(k) participants (who are currently ages 35 to 64) being able to retire at age 65 without running short of money in retirement,” the paper says.

EBRI used its Retirement Security Projection Model to estimate that the total retirement deficit for all U.S. households between the ages of 35 and 64 was $3.68 trillion in 2020. The study noted that not every U.S. worker has access to an employer-sponsored DC plan, despite legislation enacted—e.g., the Setting Every Community Up for Retirement Enhancement, or SECURE, Act of 2019, the push for additional legislation to build on those policies, and industry innovations to stem account leakage when participants change jobs.

By increasing allocations to better-performing—viz., private equity—investments, EBRI raised participants’ projected retirement readiness and reduced their retirement savings shortfalls, defined as “the present value of the simulated retirement deficits at retirement age.”

“When 15% of the equity in the TDFs is assumed to be replaced with private equity, the retirement savings shortfall reduction varies from 4.8% for the youngest cohort to 2.1% for the oldest cohort,” the paper states. “The retirement saving shortfall reduction varies from 3.2% for the youngest cohort to 1.5% for the oldest cohort when 10% of the equity in the TDFs is assumed to be replaced with private equity, and it varies from 1.8% for the youngest cohort to 0.8% for the oldest cohort when 5% of the equity in the TDFs is assumed to be replaced with private equity.”

In 2020, the Department of Labor published an information letter about adding private equity investments as a component of asset-allocation funds offered as an investment option for participants in DC plans.

According to the letter, a plan fiduciary would not violate the duties of a fiduciary solely by offering a professionally managed asset-allocation fund with a private equity component as a designated investment alternative. The letter did not authorize plan sponsors to make private equity investments available for direct investment on a standalone basis.

Despite the pro-private-equity stance of the DOL under President Donald Trump, Serge Boccassini, head of institutional global product and strategy at Northern Trust Asset Servicing, more recently said plan sponsors in the U.S. might have concerns about including such investments in their DC plan fund menu.

The EBRI research was completed before the DOL, now under President Joe Biden’s administration, issued a supplemental statement in December to clarify the 2020 letter. It cautions plan fiduciaries against the perception that private equity is generally appropriate as a component of a designated investment alternative in a typical DC plan, in response to stakeholder concerns.