A study by Pantheon has found that a pension saver could be missing out on nearly $180,000 by not including private equity in their retirement plans.
The study, which comes as private equity firms look to tap the growing defined contribution pension market, looked at what would happen if private equity was enabled as an investment option for custom target-date funds, a retirement product growing in favour in the US and UK.
“We didn’t add private equity into the framework by brute force, but included private equity as an additional option for the algorithm [that determined the portfolio construction] to choose. So it was not by construction that private equity would be part of portfolio. It could have been excluded,” said Andres Reibel, vice president at Pantheon and author of the study.
The study found that a pension plan participant could potentially increase their savings by 8.7 percent after 45 years, based on an annual investment of just under $6,500, without increasing their risk. For this result to be achieved, Pantheon said plan sponsors would need to allocate 7.1 percent of their portfolio to private equity for 30 years, reducing the allocation 5.28 percent in year 40.
“Because we have used forward looking returns the results are not based on some of the very strong exits we have seen in recent years. We think the data is unbiased and the results are encouraging,” says Reibel.
Private equity firms have long-relied on defined benefit schemes for the bulk of their funding, but are having to innovate as defined contribution plans take ever-greater market share.
According to pension consultants Towers Watson, defined contribution plans have grown at more than 7 percent per year over the last ten years, compared with 3.4 percent for defined benefit. In the so-called P7 countries – the seven countries with the largest pools of pension assets – defined contribution assets now represent more than 48 percent of total pension savings.
A Pantheon spokeswoman said “cultural and historical issues” are holding back defined contribution schemes that are able to invest in private equity from doing so. “We anticipate that greater uptake by DC schemes of private equity is likely to be a long game.” In recent years firms such as Partners Group, KKR, and Carlyle have established vehicles to open up private equity to DC plan participants and retail investors.
Pantheon declined to comment on their own defined contribution product, but it is understood to use a mixture of cash and exchange traded funds – that effectively replicate private equity market exposure – to provide liquidity.