Retail Access: Alternative Investments in DC Plans

Executive Summary

Amidst changes in the composition of US capital markets and the US retirement system towards private markets and defined contribution plans, this paper studies the implications of broadening retail investor access to "alternative investments" through defined contribution plans. The Council of Economic Advisers (CEA) finds that:

• Defined contribution (DC) plan allocation to alternative investments can have significant benefits to plan participants (retail investors), fund managers, private companies (including small businesses), financial markets, and the real economy.
• DC plan participants would benefit from diversification, higher risk-adjusted returns, and higher retirement income. Fund managers and private companies would benefit from access to a large, growing, diversified, and stickier capital base. Financial markets would benefit from enhanced liquidity and price discovery. These benefits would translate to a higher GDP.
• Across all age cohorts, we find that an allocation to private equity enhances portfolio risk-adjusted return (Sharpe ratio) and increases retirement wealth for defined contribution plan participants.
• Younger cohorts benefit more relative to older cohorts from an allocation to private equity. The two youngest cohorts see around a 2.5 percent increase in annuitized lifetime income while the gain to the two oldest cohorts is closer to roughly 0.5 to 1 percent.
• Overall, we estimate that retail investor access to private equity through defined contribution plans can result in a GDP benefit of up to $35 billion, or 0.12 percent of GDP. This estimate quantifies the benefit from expanding access to private equity only; there may be an additional benefit from expanding access to other forms of alternative investments such as hedge funds or venture capital.