Morningstar: Liquidity Top of Mind for Private Assets in DC Plans

With private asset managers’ increased push toward the $12 trillion defined contribution market comes the need for incorporating liquidity within retirement plan designs, according to a recently published white paper by Morningstar Retirement.

“Private Assets Meet Retirement Managed Accounts: A Liquidity-Centric Framework for Inclusion” argued that integrating private assets into managed accounts requires careful structuring of liquid sleeves to support participant withdrawals, routine rebalancing and unexpected market shocks.

Researchers simulated 401(k) participant behavior to test whether semi-liquid private asset vehicles could function under real-world stress. The simulated 401(k) participants enrolled in managed accounts with fictional investors based on real participant data, including age, salaries and contribution rate distributions. Each participant received a personalized portfolio with a designated allocation to private assets.

Shocking the Systems

To best understand how liquidity is strained within managed accounts, Morningstar modeled routine plan activities, such as monthly contributions, market rebalancing and investment policy updates, as well as rarer “tail” events—market-changers such as an economic downturn or geopolitical disruption.

In simulated tail events, participants’ asset allocations did not change in response to the events. At the same time, Morningstar found it unlikely that managed account providers would implement tactical tilts, which would cause effective weights of assets in the portfolio to drift from target allocations.

For a routine event like a contribution or withdrawal—made monthly—a more predictable pattern was reflected. Monthly contributions were invested pro rata, preserving each portfolio’s intended allocation.

For retirees or other participants taking withdrawals, the decumulation phase was generated by selling funds pro rata, again to maintain the portfolio’s structure.

How Liquidity Helps

Miguel Puerto Villa, a senior investment analyst of portfolio management at Morningstar Investment Management LLC, who co-authored the white paper, says liquidity matters in managed accounts because participants are “coming in and out every 15 days or every month through their paychecks.”

Rather than operating as a single pooled vehicle like a target-date fund, a managed account must absorb and fund continuous participant inflows and outflows.

When thinking of liquidity to help stabilize portfolios with private assets, Puerto Villa says it is important to consider how liquidity implications differ across asset classes. He says while private equity needs higher liquid sleeves, given that equities have relatively higher drawdowns, private credit does not need as large of liquid sleeves due to the income it is able to generate.

“If you don’t get liquidity right,” Puerto Villa says, “there’s no opportunity to actually own these assets for participants.”