Don't hold your breath for alternative investments, such as private equity or creditto appear in 401(k) plans. According to the April edition of Cerulli Edge: Monthly US Product Trends According to consulting firm Cerulli Associates, higher fees, lower transparency and less certain outcomes for these asset classes make defined contribution plan managers reluctant to include them.
As corporate pension plans divest into alternative investments, reaching 12.4% in 2022, Cerulli analysts noted that defined contribution plans face greater restrictions under the Employee Retirement Income Security Act. 1974. The ERISA rules do not explicitly prohibit the use of private funds. However, they emphasize the fiduciary duty of plan managers to provide the best possible investment options at the lowest possible fees. As a result, private funds' lack of liquidity, uncertainty and typically higher fees can open managers to legal liability.
When Cerulli asked investment managers who focus solely on defined contribution plans whether they planned to add private equity to their highly active category products, such as custom target-date funds, in the next 12 months, 46% responded “ No”. Twenty-three percent said they would consider it if they were referred by consultants, advisors or plan sponsors. Another 15% said they were still in the “fact-finding” phase of private equity investments. Only 8% said they already include private equity in multi-asset category products, while another 4% plan to add it in the next 12 months.
The attitude was a little more open to private real estate. Nineteen percent of respondents already include it in their highly active category products, while 22% are in the “fact-finding” phase. Forty-one percent said they are not planning to include private real estate in their distribution plans in the next 12 months, and 15% said they would consider it if approached by consultants, advisors or plan sponsors . According to Cerulli, what likely accounts for the difference between DCIOs' attitude toward private equity and private real estate is that the latter is, by its very nature, a long-term, uncorrelated, largely illiquid asset class.
The survey included 30 asset managers and was conducted by Cerulli in the second quarter of 2023.
Outside of legislative changes to ease the potential pressure plan sponsors face lawsuits if private funds underperform, “Defined contribution plans will be able to accommodate the changes in a significant way if they are able increase their prevalence off the shelf or to order. target funds on target date,” wrote Adam Barnett, senior retirement analyst at Cerulli, in an email. “Secondary to TDFs, greater involvement in advisor-managed accounts would also lead to significant alignment with DC plans.”
Alternative asset managers know the challenges they face in getting 401(k) plans to include alternatives. In Cerulli's survey, they placed defined contribution plans at the bottom of the institutional distribution segments, which they see as offering the best opportunities for growth over the next 24 months. Of the 20 firms that responded, only 15% expressed interest in 401(k) plans. In contrast, 65% expressed interest in very high net worth investors and family offices, 60% expressed interest in pension plans and 25% were interested in funds of funds.
“As it stands today, trying to include alternatives such as venture capital and private credit in DC plans is like trying to fit a square peg in a round hole: it just doesn't fit,” Cerulli's researchers concluded.