Exploring private market investments for today’s 401(k)s

Key takeaways:

• Private market investments like private credit, real estate and real assets may enhance diversification and potential returns in defined contribution (DC) plans.
• While some private market assets come with challenges like lower liquidity and transparency, these drawbacks may be manageable — and even beneficial — within longterm retirement portfolios.
• One way to include private market investments in DC plans is through professionally managed solutions like target date funds or managed accounts, rather than offering them directly to participants.

Defining private market assets investments

Private market investments, sometimes called alternative assets, represent a significant and relatively underutilized opportunity, often larger in scope than commonly perceived. While traditional investor portfolios typically comprise publicly traded stocks and bonds, private market investments are distinguished by their absence from public exchanges. These can include direct investments in private company equity and credit, real estate and real assets such as infrastructure or farmland. Private market investments can complement public holdings, offering diverse opportunities to potentially enhance portfolio performance.

Various private asset classes possess distinct characteristics in terms of asset type, comparable public asset class and risk/return profile.

• Private equity: Involves equity ownership in companies not listed on public stock exchanges
• Private credit: Entails lending capital to private companies through non-traditional banking channels
• Real estate: Direct investment in professionally managed real estate properties, sites and buildings that benefit from global trends
• Real assets: Investments in natural resources (e.g., farmland) and public resources such as infrastructure

Benefits

Private market investments can offer several potential benefits for DC plan portfolios. Incorporating these investments can enhance diversification, providing exposure to a broader range of the global economy and reducing reliance on traditional public equities and bonds. Many private asset classes also offer an “illiquidity premium” in the form of higher yields, which can potentially boost returns during periods when participants are not expected to access their accounts.

Private investments may also help mitigate portfolio risk through exposure to assets with different return drivers. Additionally, these investments can provide access to unique opportunities not available in public markets, offering the potential for longterm value creation. Certain private assets like real estate, farmland and infrastructure, may even serve as an inflation hedge.

Considerations and potential drawbacks

While the benefits of incorporating private market assets into DC plans can be compelling, there are also valid criticisms and concerns that plan sponsors must carefully evaluate.

First and foremost is the relative lack of transparency and disclosure requirements compared with publicly traded securities. The SEC mandates a rigorous disclosure regime for public asset classes, but disclosure from underlying private companies is often voluntary or lacking in detail. Alternative investments are typically designed for professional asset managers who have the expertise to analyze these less transparent opportunities, rather than for general retail investors.

Another common criticism is the reduced liquidity of private investments. However, this lack of immediate access can be viewed as a potential benefit specifically within the context of a DC plan. Since the assets in a DC portfolio are generally intended to be held for the duration of a participant’s working career, the reduced liquidity of alternatives may not be a significant impediment. Additionally, the higher yields often associated with illiquid private market investments can help compensate for this lack of liquidity. And in the event of an emergency need for funds, the more liquid publicly traded portion of the portfolio would typically still be available.

Implementing private assets within a DC plan

As the DC market continues to mature, plan sponsors and consultants are evaluating the benefits of traditional active asset management versus passive indexing models, often with an eye on cost savings. The nuanced discussion centers on how to optimally combine these different investment approaches. With this backdrop, well-designed blended strategies have the potential to become the new standard for default investment options, offering a balanced approach that serves the interests of both plan sponsors and participants.

Certain market segments, such as large-cap U.S. equities, are highly efficient, making it challenging for active managers to consistently outperform. In contrast, areas like emerging markets or small-cap stocks often present greater opportunities for skilled managers to add value. Private assets, in particular, represent an area where we believe active management is essential. Private real estate, private credit and other non-public assets may offer compelling diversification and enhanced income opportunities when supported by expertise and active oversight. While some sponsors attempt to use proxy, index-based strategies, such as publicly traded REITs, to gain exposure to these markets, these approaches often fall short in effectively replicating the performance and characteristics of the underlying private assets.

The cost of active management, and specifically the fee structure of private investments requiring specialized managers, is a common criticism. However, recent litigation trends have not deemed the use of actively managed funds as inherently imprudent. The key is to demonstrate a thoughtful, transparent process for selecting and monitoring investments, with a clear rationale for how each component contributes to the overall investment objective. By offering a blended approach, plan sponsors can demonstrate a commitment to both cost efficiency and investment excellence, a balance that aligns with their fiduciary responsibilities.

Embedding private assets with care

At Nuveen, we have long recognized the potential benefits that alternatives can provide within a professionally managed retirement portfolio. We have been a leader in incorporating our private market assets into our funds.⁶ Nuveen is a top five real estate manager, with nearly $300 billion in alternative assets under management.⁷

As the various government departments consider the use of private investments within DC plans, we believe that their inclusion must be done thoughtfully to avoid unnecessary fiduciary risk. We believe that these investments are typically best applied within professionally managed portfolios, such as, target date funds, insurance general accounts or carefully monitored in-plan managed account offerings.

By embedding private solutions inside professionally managed portfolios like target date funds, the end investor and plan sponsor can mitigate many of the challenges, such as the complexities and illiquidity concerns, that would accompany making these assets directly available within a plan’s investment menu.

As plan sponsors look to improve retirement outcomes for their workers, they should rely on their investment consultants to assist them with their plan’s investment menu design. This includes ensuring that their participants have access to the right mix of asset classes, both public and private, but that these are managed within professional portfolio, most easily achieved through target date funds with an embedded annuity — some of which may already include allocations to alternatives.

Nuveen has been an industry leader in private markets for decades. The question is not whether alternatives belong in DC plans, but rather how to incorporate them thoughtfully to enhance retirement security. We are well positioned to offer participants access to private assets through our target date funds and alternative-focused CITs that can be used as components within custom solutions and managed accounts.