Private Assets in Target Date Funds: Aligning Retirement Outcomes with Plan Sponsor Confidence

As the defined contribution (DC) landscape evolves, so too must the tools we use to help participants retire with confidence. In Target Date Fund (TDF) investing, we believe diversification is not a luxury, it’s a key consideration. This article explores why private markets may represent a logical next step in improving portfolio diversification, and how State Street’s thoughtful approach to integration can address concerns participants and plan sponsors may have with respect to the inclusion of private markets exposures in a DC plan.

Improved outcomes: The case for private assets in TDFs

While the concept may seem novel, private markets have long played a role in institutional portfolios. What’s changing now is the scope and sophistication of how these assets are integrated. As of 2024, the average US DC plan has less than 2% of assets allocated to private markets,¹ and within the $3.5 trillion Target Date market, we estimate that only $115 billion is allocated to TDFs with private equity and/or private real estate exposure.² (See Private Markets in Target Date Funds – Why Now? for a closer look.) In contrast, the average public U.S. defined benefit (DB) plan features a 25% allocation to alternative asset classes.¹ Investment earnings have consistently accounted for between 60 and 65 percent of public pension fund revenue over 30-year periods, and private market exposures have historically played a key role in DB plans outperforming DC equivalents.³

In our many conversations with plan sponsors, consultants and advisors, the speed with which the high level case for ‘why’ private markets has been acknowledged and embraced is striking relative to past themes in the notoriously slow-to-move retirement market. However, there is room for nuance in the ‘how’ – and we believe implementation decisions can make a significant difference in the efficacy of the allocation. Identifying the optimal private markets exposure and establishing a liquidity framework that allows for meaningful exposure throughout participants careers is, in our view, the most effective way to positively impact retirement outcomes.

In designing our private markets glidepath, we modeled a number of different investment approaches including single-sleeve allocations to private equity, credit and real assets. Each asset class offers unique potential benefits, but comes with cyclicality and idiosyncratic liquidity risks. For example, interest rate and valuation headwinds have recently led to a challenging liquidity environment for commercial real estate. Similar cyclicality is reasonable to expect in private equity (“PE”), as periods of lower exit activity have the potential to impact returns and liquidity as PE vintages extend beyond their expected holding period.

We believe a consistent allocation to a diversified private market portfolio – e.g. private equity, credit and real assets –helps directly address these risks. In our due diligence, the scale, multi-asset exposure, and cash flow generation of the portfolio were key factors in evaluating liquidity. We stress-tested the most extreme market environments, drawing on 20 years of participant flow data that we have for our TDF business to evaluate the potential impact of private markets on tracking error and liquidity.

We believe that putting liquidity at the forefront of our process allows for more meaningful exposure throughout participants’ careers, potentially improving the impact on participant outcomes. For example, a dedicated private equity portfolio may carry the highest long-term return expectations, suggesting a strong fit in the wealth accumulation phase. However, if this allocation is sourced directly from public equity (due to its higher volatility) and requires a meaningful liquidity sleeve (due to its relative illiquidity) the impact on overall portfolio return may be muted. We believe a multi-asset portfolio, comparatively, may potentially be sourced from a blend of stocks and bonds if the risk profile of the strategy is lower than traditional equity and historical diversification benefits of the portfolio support the case. We also believe that to capture the potential alpha and diversification benefits from private markets, incorporating a broad opportunity set with tactical flexibility to allocate to asset classes where there is relative value, at the discretion of the private markets manager, is a prudent risk management tool.

The potential impact of private markets on participant outcomes is becoming increasingly difficult to overlook. While private equity, credit, and real assets all exhibit different risk, return, and liquidity profiles, we believe that a diversified multi-asset private market portfolio with tactical flexibility across a broad opportunity set can play a key role in addressing objectives at each stage of the glidepath – both to and through retirement. According to our analysis,a stable 10% allocation to this diversified portfolio over a long time horizon time has the potential to improve retirement balances by an estimated 15% at age 65,⁴ potentially extending asset longevity in retirement by eight years.