This week, MarketWatch published an article highlighting a recent Urban Institute study that showed, on average, the addition of private equity investments to 401 (K) retirement plans produced higher returns in the long-run when compared to traditionally diversified retirement portfolios. The study specifically found that the inclusion of private equity investments could boost average retirement fund returns by nearly 10% over the course of a fund’s lifetime. The Urban Institute’s study comes just a year after the Department of Labor issued guidance allowing private equity investments to be offered to employer-sponsored retirement plans that invest in multiple asset classes.
- “PE investments—as the Urban Institute noted—are expected to earn higher returns than public stocks. Other institutions are saying much the same. J.P. Morgan, for instance, is telling investors to look beyond traditional asset markets to find higher returns.”
Key takeaways from the Urban Institute report include:
Overview: “Our results show that adding limited PE funds to retirement savings funds would likely raise the average rate of return and increase average retirement savings account balances. These gains occur because PE funds offer potentially higher returns than public stocks, on average, and because PE adds diversification to savings portfolios. Even under our most pessimistic assumptions, adding PE to the mix of investments can be beneficial. The average outcomes were less favorable than under the baseline in only two simulated scenarios…”
Diversification: “Diversifying investments to include PE increased average returns under scenarios that assumed a non-negative alpha, with gains ranging from 0.05 percent under scenario 7 to 4.6 percent under scenario 16. Average returns increased even with alpha equal to 0 because of the diversification provided by PE investments.”
Increasing retirement savings: “Our simulations show that the availability of a PE investment option in DC retirement plans would increase average account balances under 14 of our 16 scenarios… A scenario with more neutral assumptions (1.0 percent alpha, 1.5 beta, and maximum PE share of 15 percent) would increase average accounts balances at age 65 by $27,600, or 6.6 percent.”
PE Outperformance: “Economists believe that, because of the risk stemming from limited liquidity and information, investors require higher returns from PE than from public equities. Fund managers, with their specialized expertise and hands-on approach to investing, so far have delivered this risk premium. Despite the challenges in measuring PE returns, which arise from the absence of a market, the literature suggests that PE funds have outperformed public stocks over the past three decades.”
You can read the full MarketWatch article here.