While allocations to alternative investments have long been a staple of endowment and pension portfolios, they have yet to penetrate the defined contribution (DC) market. However, the return profiles and unique diversification of illiquid alternatives may offer an attractive investment opportunity for DC plan participants, according to the latest Cerulli Edge—U.S. Retirement Edition.

Currently, DC institutional consultants report very little use of illiquid alternatives within DC plans; less than 1% of DC plans offer private credit, private equity (PE), and hedge funds. Private real estate is the only outlier, with 10% of plans intermediated by an institutional investment consultant containing private real estate. “As the U.S. experiences high inflation, there is a compelling case to be made for private real estate in DC plans, particularly for older participants without the longer time horizon and high public equity exposures of their younger counterparts,” notes David Swart, associate analyst.

Only 4% of target-date managers allocate to PE and private debt, and none allocate to hedge funds within their off-the-shelf target-date series. Despite the complexity and the challenges of providing PE and hedge funds in the DC market, further investment, particularly within pooled vehicles such as target-date funds, may help retirement investors achieve superior risk-adjusted returns and diversification benefits. “While retirement investors should focus mostly on the long-term horizon, diversification across asset classes, including alternatives, can prove beneficial to achieving a balance and consistent return capable of sustaining income and quality of life in retirement,” continues Swart.

Cerulli acknowledges, however, target-date managers and plan fiduciaries may be hesitant to allocate to alternatives given the changing regulatory guidance. Cerulli expects conversations related to the inclusion of private equity in DC plans will remain largely relegated to large and mega plans and the consultants that work with these plans. “In the long run, certain consultant-intermediated pooled employer plans (PEPs) that achieve significant scale may look to alternatives to enhance the attractiveness of their investment lineup to prospective employers,” concludes Swart.