DC plans aren’t diving into the private markets

As popular as private market investments are, particularly in the institutional space, nobody should expect them to become a staple fixture in people’s retirement plans anytime soon, according to new research from Cerulli.

The new report from Cerulli notes that 401(k) plans typically offer a narrow range of investment options, with target-date funds being the most prevalent. This limited selection often forces participants to choose from options that may not fully align with their investment preferences or level of financial knowledge.

DC plans generally include 20 to 25 investment options, with a heavy emphasis on target-date funds designed for long-term retirement outcomes. This often results in participants being restricted in a sense, limiting their exposure to potentially more diverse investments.

"On the other hand, plan sponsors often feel trapped, afraid of including funds that could be interpreted as overpriced and underperforming, with litigation being a frequent outcome," the report said.

Legal challenges are a significant concern, particularly those related to excessive fees charged by recordkeepers or within the plan’s investment options. Under ERISA, fiduciaries are required to offer the best investment options at the lowest feasible cost.

That makes including alternative investments like PE a thorny business, as those funds typically come with higher costs and significant operational expenses, in contrast to the lower costs associated with target-date funds. In some of the worst cases, administrators who failed to meet those requirements have been sued for breach of fiduciary duty.

Furthermore, the inherent characteristics of some private market assets, such as their illiquidity and lack of transparency, make them a less suitable fit for DC plans governed by strict regulatory and fiduciary standards.

"However popular they are and will continue to be, it is difficult to see a path forward in DC for alternatives such as private credit, although a solution is not out of the realm of possibility in the next decade," Cerulli said.

A survey accompanying the report reveals a tepid outlook on the future integration of private market funds into DC plans. More than half of the defined contribution investment-only asset managers surveyed indicated they have no plans to add or have not considered adding major private market fund types to their offerings in the near future.

Asset managers aren’t blind to the lack of interest, Cerulli said. When asked to identify which institutional investor types would be their most promising prospects over the next 24 months, the asset managers it polled ranked DC plans last, with only 15 percent showing interest in wooing the DC plan market.

Nonetheless, Cerulli isn’t writing off the potential for private market investments in DC plans, as some custom target-date funds have begun incorporating elements such as private real estate and PE to a limited extent.

"The correct path forward has yet to present itself, and a great deal of work around unique structures and liquidity offerings still is required," Cerulli said.