Private Investments Are Coming for 401(k)s. There’s a Big Illiquidity Problem

Just because you can, doesn’t always mean you should. 

There’s a good argument for including private assets in 401(k) plans and that’s illiquidity. Because retirement savers are by definition long-term investors, they can benefit from locking up their assets, and the illiquidity premium that compensates them for the inability to quickly exit positions. That same illiquidity, though, presents major practical challenges that can end up robbing retirement investors of the intended benefits of private market participation. To work in 401(k) plans, some private equity investments would need far more readily available cash than investors might assume, sometimes up to 40% of the portfolio, per a recent Morningstar analysis. The potential drag on net-of-fee performance is real, the authors warn, and the propensity of novice savers to dump investments during market stress is nothing for fund managers to shrug off. 

Nonetheless, clients who embrace private assets could see higher returns, but only if they avoid ill-timed trading and are mindful about fees. “We believe a modest allocation to private markets can make sense for both savers and actual retirees,” said Michael Conrath, chief retirement strategist at J.P. Morgan Asset Management. “But there’s a big behavioral hurdle we need to get over before more robust distribution can happen.”

A Supply Side Push 

Last week, Invesco launched the Invesco Core Plus Real Estate Trust, a collective investment trust providing access to private real estate through a daily valued structure. The trust gives exposure to core plus private real estate, complemented by an allocation to passive US REITs to support daily liquidity. The trust is structured as a daily valued CIT that participants can buy and sell at will: 

• Fewer than 1% of DC industry assets are currently allocated to private market investments, Greg Jenkins, managing director of DC solutions at Invesco, said in a statement.
• However, Invesco expects the rise of professionally managed products, like target-date funds and managed account portfolios, to change the calculus. 

“There’s a big supply-demand imbalance when it comes to private assets in 401(k) plans,” observed Jeri Savage, lead retirement strategist at MFS, who is seeing lots of product development but little plan sponsor interest. “That’s not a statement about the merits of these investments for retirement portfolios, which can work well in professionally managed allocations. It’s just the reality today in DC plans.”

In-Plan Income Struggles, Too. The slow takeup of private assets by DC plan sponsors and participants mirrors their behavior with in-plan annuities. “Legislative changes have eased the regulatory challenges of putting annuities on DC plan menus, and there has been an executive order seeking to promote private assets,” Savage explained. “What’s holding them back is the perceived complexity and potentially the cost, as well as first-mover risk. Plan sponsors are afraid of getting sued for doing something different.”