Should Defined Contribution Plans Include Private Equity Investments?

Abstract

This paper evaluates the pros and cons of including private equity fund investments in defined contribution plans. Potential benefits include higher returns and improved diversification as well as a relatively safe method for accessing investments previously only available to institutions and the very wealthy. Despite these enticing benefits, they need to be weighed against potential challenges and costs that may arise from creating this broader access to private funds. The complicated structure and uncertainty around the mechanism to provide required liquidity backstops may bring increased fees or even disrupt the private fund model.

Keywords:

• defined contribution
• private equity
• retirement plans

PL Credits:

• 0.75

Disclosure statement

None of the authors have any financial interest or benefit that has arisen from this research.

Acknowledgements

The authors thank TJ Carlson, Tim Riddiough, and Andrea Carnelli Dompé for valuable comments. The authors also thank Burgiss for providing data for the analysis.

Notes

1 The U.S. Department of Labor describes ERISA as follows: “The Employee Retirement Income Security Act of 1974 (ERISA) is a federal law that sets minimum standards for most voluntarily established retirement and health plans in private industry to provide protection for individuals in these plans. ERISA requires plans to provide participants with plan information including important information about plan features and funding; sets minimum standards for participation, vesting, benefit accrual and funding; provides fiduciary responsibilities for those who manage and control plan assets; requires plans to establish a grievance and appeals process for participants to get benefits from their plans; gives participants the right to sue for benefits and breaches of fiduciary duty; and, if a defined benefit plan is terminated, guarantees payment of certain benefits through a federally chartered corporation, known as the Pension Benefit Guaranty Corporation (PBGC).”

2 The Supreme Court allowed continuation of a lawsuit against Intel by a former employee who claimed that Intel’s company retirement plan was over-allocated to hedge funds and private equity and therefore created a breach of their fiduciary duties. The crux of the argument was that even though employees were informed via email with links to the documents, this was not enough for the plan participants to have “actual knowledge” around the investments (Chung 2020).

3 See, for example, Fermand et al. (2018) and citations therein.

4 For a discussion of how the returns of publicly traded real estate compare with private equity real estate, see Ghent, Torous, and Valkanov (2019).

5 While we report up-to-date performance data in our tables and figures we do not include funds with vintages after 2017 because most of these funds are still in their investment periods and have made few distributions.

6 Additional results and discussion of benchmarking are provided in the IPC whitepaper “Performance Analysis and Attribution with Alternative Investments.” Available at https://uncipc.org/index.php/publication/performance-analysis-and-attribution-with-alternative-investments/.

7 See also Chingono and Rasmussen (2015).

8 See a summary of the literature and related arguments in Brown, Carnelli Dompé, and Kenyon (2020), Public or Private? Determining the Optimal Ownership Structure, SSRN working paper #3529421.

9 This is according to data provided by Burgiss as of September 2021.

10 See, for example, Chen, Goldstein, and Jiang (2010), Coval, and Stafford (2007), Falato, Goldstein, and Hortaçsu (2021), Goldstein, Jiang, and Ng (2017), Greenwood and Thesmar (2011), and Kacperczyk and Schnabl (2013).

11 However, Braun, Jenkinson, and Stoff (2017) suggest that deal-team performance remains persistent.

12 See, for example, Reserve Bank of Australia (2020).

Additional information

Notes on contributors

Gregory W. Brown

Gregory W. Brown is a Sarah Graham Kenan Distinguished Professor at the UNC Kenan-Flagler Business School, Chapel Hill, NC.

Keith J. Crouch,

Keith J. Crouch, CFA, is a director at Burgiss.

Andra Ghent

Andra Ghent is a professor of finance at the David Eccles School of Business, University of Utah.

Robert S. Harris

Robert S. Harris is a C. Stewart Sheppard Professor at the Darden School of Business, University of Virginia.

Yael V. Hochberg

Yael V. Hochberg is a Ralph S. O’Connor Professor in Entrepreneurship and professor of finance at Rice University, Houston, TX.

Tim Jenkinson

Tim Jenkinson is a professor of finance at Said Business School, University of Oxford.

Steven N. Kaplan

Steven N. Kaplan is a Neubauer Family Distinguished Service Professor of Entrepreneurship and Finance at the University of Chicago Booth School of Business.

Richard Maxwell

Richard Maxwell is a PhD candidate at the UNC Kenan-Flagler Business School, Chapel Hill, NC.

David T. Robinson

David T. Robinson is a James and Gail Vander Weide Professor of Finance at the Fuqua School of Business, Duke University, Durham, NC.