Why Alternative Assets Could Reach Retail Investors
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Alternative asset classes including real estate, private equity, and, increasingly, private credit have been mainstays in institutional portfolios for decades. Over the past five years, these asset classes have trickled down to wealthy individual investors as well, thanks to innovative fund structures, advancements in back-office technologies, and a greater focus by alternative managers on this segment.

But minimum investment requirements and other restrictions have largely kept ordinary retail investors from participating. Such restrictions are in place for good reasons — to protect small, unsophisticated investors from complex, expensive, illiquid investments that might not suit their needs and risk appetites. Alternative managers, for their part, are focused on raising capital as efficiently as possible — small dollar, mass market retail is not attractive from that standpoint. We don’t see these conditions changing anytime soon.

However, there is one place where we do see alternative investments, particularly private assets, reaching Main Street: defined contribution (DC) accounts.

The case for alternatives in defined contribution accounts

The arguments in favor of alternatives are compelling.

Standard DC portfolios are not as efficient as they could be

The overwhelming majority of flows into DC plans go to target date funds, which typically consist of traditional stocks and bonds. For plan participants who build their own portfolios, investment options are usually limited to different flavors of public equities and a scant selection of public bond funds. While there is a huge benefit to simply getting participants to invest in a balanced stock/bond option, by restricting investment options to traditional stocks and bonds, plans are limiting participants’ options to invest in more diversified and efficient portfolios. This is borne out in the data where defined benefit pension portfolios, which have higher allocations to alternative assets, have delivered similar returns to DC plans over the years, but with less risk and less severe drawdowns.

Exhibit: US retirement options — asset allocations and key metrics
401(k) plans versus top 200 public/private DB plans (2023)
Notes: 401(k) allocations based on data from Vanguard with estimates applied for Public RE. 401(k) returns based on Form 5500 filings at Department of Labor 2. DB pension allocations based on data from PI online for top 200 public and private plans. DB returns based on Form 5500 filings at Department of Labor
Source: US Department of Labor, Pensions & Investments, Vanguard, Oliver Wyman analysis

DC participants are missing out on key economic opportunities

The public markets represent a declining slice of the economy. Some of the most innovative, profitable, and dynamic companies are privately held. Many are also much smaller than the industry giants that make up typical fund holdings and passive indices. DC plan participants have no way of accessing those opportunities and the broader economic prosperity they help drive.

Retirement accounts are ideal for retail investors to hold alternative assets

The whole purpose of DC plans is to encourage long-term, buy-and-hold investing to give plan participants the advantage of compounded returns over decades, not weeks or months. Consistent with that philosophy, DC plan participants face penalties for accessing their holdings prior to retirement age, which makes them structurally better suited for holding some portion of less liquid asset classes. What’s more, the investment lineups in DC plans are professionally curated by plan sponsors and their investment advisers, which means participants benefit from institutional-quality investment selection and manager due diligence, as well as preferred institutional pricing.

Alternative investments have political appeal

Policies that allow American workers to invest like professional investors in the US economy are likely to have broad appeal. Most alternative investments are focused on private businesses, real estate, and US infrastructure — categories that resonate with ordinary American investors and the business community.

In countries like Australia, the UK, Switzerland, and the Netherlands, DC plan participants already have exposure to private markets in their portfolio lineup. In some geographies, momentum is brewing for increased allocations to alternatives and private markets. For example, the UK government has proposed allocating 5% of DC pension assets to unlisted equities by 2030.

Potential obstacles to widespread adoption of alternatives in DC accounts

Our base case is that policymakers in the US will open the door to DC retirement accounts for alternative and private markets investments over the next four years. Three surprises could derail these efforts, however.

1. Scandals or poor performance could discourage DC plan changes

Few events attract regulatory attention or mass scorn like massive trading losses or misappropriation of funds. Following such events, there would be blowback from the public and regulators stalling progress. Poor investment performance over the next year or two, especially compared with headline returns of the US equity and credit markets, would also likely dampen enthusiasm.

2. Lack of industry advocacy and congressional challenges could stall DC plan changes

Several leading firms with strong government relations teams are already lobbying for changes in DC plan regulation. Industry consortiums and retirement think tanks also can play important roles in shaping retirement policies. But for any meaningful changes to occur, the industry will need to maintain, if not increase, their advocacy. If interest wanes or turns to other, more urgent campaigns, there is a risk that momentum will fade, especially given the ever-present dysfunction and distractions in Congress.

3. Technology costs could hinder DC plan upgrades

DC plan administrators operate at razor thin (and sometimes negative) margins. They have extremely high technology investment requirements, and many rely on outdated platforms that make accommodating new asset classes, especially more complex ones, very difficult. Absent strong incentives to make the necessary upgrades or significant effort from asset managers on their own, it will be difficult for them to support any major shift, even if the legislative and regulatory environments are favorable.

This article is part of our Known Unknowns report highlighting the debates that will shape the future of financial services