Private Markets for DC Plans: Evolution or Revolution?

The use of private assets within defined contribution plans is nothing new, according to Anne Lester, a member of Partners Group’s board of directors. Speaking at the PLANADVISER360 Conference on November 3 in Scottsdale, Arizona, Lester remembered that when she took over management of J.P. Morgan’s commingled diversified fund in 2000, it was already integrated into 401(k) plans and had included private real estate for decades.

Since joining global private markets firm Partners Group, Lester has seen interest in private markets increase significantly. The firm has $174 billion in assets under management, half of which is in private equity, according to Partners Group.

The firm launched its first open-ended evergreen fund more than 20 years ago, only available to private investors in Europe. In 2015, the firm started its defined contribution effort in the U.S., and Lester claims the company works for the “democratization of private assets for individuals.”

“Most working Americans don’t have access to capital market investments except in their 401(k) plan,” Lester said. “To me, it is an issue of fundamental fairness.”

Diversification Benefits

Anne Lester. Photo by Anthony Collins

Lester said that during her time at J.P. Morgan, her conversations with defined contribution and defined benefit clients included talks of a different kind of diversification within their plans.

“We were talking about crazy stuff in 2000, like high-yield, emerging markets. … That was crazy talk. They were ‘alternatives,’” said Lester. “That stuff is absolutely standard now and is part of a typical efficient frontier.”

Comparing 20-year performances of long-term asset classes from 2004 to 2023, Lester found that, generally, indexes of private assets, such as the Cliffwater Direct Lending Index, NCREIF Property Index and the Cambridge Private Infrastructure Index, had higher annualized returns than most indexes of equities and bonds. While the Russell 3000 had a higher annualized return, it also had a higher degree of risk than the tracked private asset indexes.

Lester said those sorts of higher returns for the same level of risk or the same level of returns for lower risk are key to maintaining a higher 401(k) plan balance for contributors and distributors.

Lester gave an example of taking a standard portfolio of 60% equities and 40% bonds, and then moving a tenth of the public equity allocation into private equity and a tenth of the fixed-income allocation into private credit. Lester said that led to a 1.2-percentage-point increase in return and a 0.3-percentage-point decrease in volatility in the portfolio over 10 years.

Partners Group made a private equity investment in 2018, buying a big-box store from India, Vishal, that it sold at the end of 2020 for a 35% internal rate of return; Vishal is now a public company. Other private market investments made by Partners Group included an investment in Ritz-Carlton’s Dallas hotel renovation and a private infrastructure investment into VSB Group, a German renewable energy developer and manager..

More Companies Stay Private

The move into private markets not only helps diversify portfolios, but it follows a current trend in the capital markets of public companies choosing to go or stay private, according to Lester.

“[Companies] don’t need to go public now to access the capital that they need to grow,” she said.

Lester said it is the job of 401(k) investors to follow the market, and with increasing amounts of the economy being held privately, it is important to have a broad, diversified exposure.

The difficulty in private asset investments lies in the valuation process, but, as Lester said, “as more and more companies are offering private market products and … real America is buying into these products, we will see increasing transparency there.”

Lester said advisers should be aware that these investments may not be suitable for everyone. Advisers need to communicate with plan sponsors to understand participant demographics first and to make sure the investment time horizons make sense for the plan’s participants. For private equity investments, the holding period can typically be five years, while real estate and infrastructure can take 10 years or more. On the private credit side, the holding period typically only lasts three or four years.

“Private asset allocations will make sense over time, just like any investment decision,” Lester said.