Diversifying target-date funds by incorporating illiquid assets — such as private equity, real estate and infrastructure — could result in a 0.15 per cent annual increase in return over a decade, according to a recent report by Georgetown University’s Center for Retirement Initiatives in partnership with CEM Benchmarking Inc.
The report was authored by Angela Antonelli, a research professor at the university and executive director of the CRI, along with CEM contributors Chris Flynn, Quentin Spehner and Kevin Vandolder. Focusing on the period between 2011 and 2020, it assessed how defined contribution pension plan members’ experiences and outcomes would have changed during this period if the TDFs in their plans had higher allocations to illiquid assets.
Looking at CEM data, the report noted U.S. defined benefit plans outperformed the average return of DC plans by 180 basis points a year between 1998 and 2005. When the data was updated in 2017, it found DC plans had narrowed the gap to 46 basis points in the period between 2007 and 2016. “Most of this narrowing was attributed to an improved average asset mix held by DC participants, an improvement driven by assets flowing into TDF options that are professionally managed,” said the report.
The report presented three DC investment scenarios: adding a 10 per cent private equity sleeve; adding a 10 per cent real assets (real estate and infrastructure) sleeve; and adding smaller allocations of both, all substituted for traditional stocks and bonds. It concluded the scenario with a mixture of both private equity and real assets resulted in the highest percentage of returns, with 82 per cent better outcomes over a 10-year period. For a DC plan member with $48,000 per year in retirement income, the result would be an additional $2,400 per year.
“There’s no question DC plan sponsors should be looking at adding illiquid investments,” says Flynn, head of product development and research at CEM. “However, whether they should be throwing money into it tactically is another issue. There are a bunch of forward-looking issues that you’d be wrestling with, but I think it would be strange to not be having the conversation.”
Concerns around valuation frequency and liquidity are perhaps overstated, he notes. “It should be stressed that these are multi-decade long savings vehicles. Obviously, there can be issues: people move jobs, they’re trying to roll over one fund into another and so on, but the industry and record keepers have a lot of data around the movement in and out of target-date funds. So there is a capability to put a reasonable framework around, for example, how much liquidity is needed.”
As well, many real asset products have a set term, such as a five-year commitment, and glide-path managers will take advantage of that, says Flynn. “They’re going to put younger people in private equity that’s likely to be realized and cash returned before they get to retirement.”
For DC plan sponsors also thinking about supporting members during the decumulation phase, there are attractive, yield-generating investments in the real asset world, he adds, so they may also consider including these assets in the drawdown stage.