Private Assets in 401(k)s Add Modest Value: Morningstar

Are private markets in defined contribution plans worth it? For some people, sometimes.

The White House and asset managers are looking to open up private market assets in all Americans’ portfolios, not just institutional investors’. And while many advisors are cautious, citing limited liquidity, opacity and greater potential for losses, private markets could actually do some good for clients. Just don’t get too excited. Private funds may add value, albeit modest, to 401(k)s according to a Morningstar analysis this month. The research found that advisors don’t necessarily need to dive headfirst into alternatives just yet, but dipping your toes in ain’t bad.

“The pricing mechanism itself can add to long-term performance by lowering correlation and volatility,” said Hal Ratner, head of research for Morningstar Investment Management. “This doesn’t mean there’s less risk per se, but it implies that under a broad range of scenarios, privates — even if their expected returns are close to those of publics — can add value.”   

Put to the Test

The analysis looked at the 401(k)s of roughly 260,000 people across different ages and contribution rates, while also factoring in things like inflation, salary growth and Social Security payments in retirement. Through 5,000 simulations, Morningstar tested what returns would be like if up to 15% of each persons’ account was dedicated to evergreen, or semi-liquid, funds — private investment vehicles that offer some liquidity compared with closed-end structures often used by institutional investors.

In every scenario, private markets improved retirement outcomes and were never worse than if someone was exposed only to public markets. The results were far from terrifying, but they weren’t necessarily mindblowing, either: 

• For higher-balance savers and those expecting to not lean as heavily on Social Security in retirement, the private assets provided between $210 and $1,770 a year, depending on the allocation size.
• Meanwhile, those with smaller balances and lower contribution rates, gained between $60 and $400 a year, thanks to their private investments.

For the latter group, Ratner said private market assets probably aren’t worth the risk. However, he added that private credit would be a better first choice if they wanted to add some diversification to their accounts. “First, the frequent cash flows mean that they can provide tangible value immediately,” he told Advisor Upside. “Second, their holdings have a finite and predictable life, thus making liquidity projections comparatively easy.”