Adding an asset class that increases return in 401k target date fund portfolios without additional risk? Sign us up (maybe).
London-based Pantheon, a global private equity, infrastructure and real assets investor, took a look at whether the inclusion of private equity into custom target-date funds could potentially increase expected retirement returns without assuming more risk.
The results found that a 401k plan participant could potentially increase the total amount “saved and distributable” by approximately 8.7 percent at the target date fund’s maturity in year 45, assuming that the plan participant invested $6,424 annually through the lifespan of the fund.
In dollar terms, that additional potential return equated to $172,794 of potential savings at year 45.
The study took a prospective approach, using the assumed forward returns of the JP Morgan Asset Management 2016 Long-Term Capital Market Assumptions. The annual publication sets out expectations for how risk, return, and correlations across asset classes may develop over coming decades.
The Pantheon research team sourced its target date fund glide path data (the asset class weights) from Fidelity. The team then added private equity into the target date fund asset class mix to see whether that inclusion had the potential to enhance expected returns, while keeping risk constant.
In noted that, obviously, the potential additional savings depend on the annual contributions made and on the allocation made to private equity. However, the study found that the optimal allocation was 7.1 percent during the first 30 years of the target date fund, followed by an allocation of 6.98 percent, 6 percent and 5.28 percent in years 30, 35 and 40 respectively.
The study further found that higher allocations to private equity in the first 30 years of the target date fund could potentially increase its performance further still, while not significantly increasing risk.