Can Adding Private Equity to TDFs Boost Performance?

Adding private equity to a custom target-date fund (TDF) could improve expected returns without incurring significant risk, according to a study by Pantheon, a private equity and real assets investor.

The firm found that a defined contribution (DC) plan participant could potentially increase savings distributable by about 8.7% at the funds maturity in year 45 by adding private equity, generating a potential return with an additional $172,794—assuming an annual investment of $6,424 through the fund’s lifespan.

The study suggests that annual savings of $12,000 could generate additional savings of $322,779; and annual savings of $18,000 could lead to additional savings of $484,168.

Furthermore, the firm found that higher allocations to private equity during the first 30 years could enhance the fund’s performance even further. Pantheon defined the optimal allocation as 7.1% during the first 30 years of the TDF, followed by an allocation of 6.98%, 6% and 5.28% in years 30, 35 and 40 respectively. Of course, past performance is no guarantee of future returns.

As reference data, Pantheon turned to the assumed forward returns of the JP Morgan Asset Management 2016 Long-Term Capital Market Assumptions. This annual publication outlines expectations of how risk, return, and correlations across asset classes may develop through coming decades. Pantheon took this approach “because it is more conservative than using historical returns as the J.P. Morgan forecasts factors in declining excess private equity returns.”

The research team drew TDF glide path data from Fidelity Investments. The firm notes “The TDFs we sourced from Fidelity had maturity dates between 2020 and 2060. Since the maturity dates of the sourced TDFs lie in the future, the glide path data represents Fidelity’s current expectations of future asset allocations.” The team then added Private Equity into the TDF asset class mix to examine whether its inclusion could significantly increase expected returns without changing the TDFs risk profile.

The full study can be found at Pantheon.com