How Are Private Markets Supposed to Fit into DC Plans?

It’s less of a question of should and more an issue of how.

Washington, DC, and asset managers alike think private market investments in employee benefits plans are the best thing since sliced bread. Financial advisors are much more skeptical, concerned about illiquidity, high costs and opacity. While there may be ways of putting private investments in 401(k)s that complement the plans, they necessitate careful engineering, small allocations and coordination across a fragmented retirement system.

“Meaningful solutions require advisors, asset managers, and recordkeepers to work together from the outset,” Hal Ratner, head of research, and Miguel Puerto, senior analysts at Morningstar said in a report. “With this collaboration, private markets can be thoughtfully integrated in ways that enhance participant outcomes.”

A Little Wiggle Room

Private assets are going to need a buffer. If an investment vehicle is going to be exposed to private equity, private credit or some other type of illiquid alternative, it requires public exposure that can support rebalancing and provide daily pricing stability, Ratner told Advisor Upside. “Your problems start to go away with that liquidity sleeve,” he said. Some types of semi-liquid funds, like the ones pretty much all of Wall Street has been partnering up on, may be a solution, he added.

Even then, private markets are unlikely to play a starring role. If they become a regular feature in defined contribution plans, allocations will probably remain small, serving as a complement rather than a core holding. “For institutions, liquidity matters less than predictability,” Ratner said. “In the DC space, there’s no specific spending schedule. You don’t know when participants will need their money, so the benefit isn’t quite the same.”

First Things First. Interestingly, Christine Benz, director of personal finance and retirement planning for Morningstar, argued that alternatives in 401(k)s are a solution in search of a problem. She called them “a distraction at best, and a payday for high-fee asset managers at worst,” in a recent blog post.

Ratner agreed, though with a caveat. “She’s right. If you wanted to order all the things that needed to be addressed in DC plans, getting private exposure is close to the bottom, if not the bottom,” he said. “But that doesn’t mean it’s not worthwhile.”