Private Markets in Target Date Funds – Why Now?

Target Date Funds have become the primary investment vehicle for DC plans. At the same time, accessibility of private markets has meaningfully improved. Yet DC plans have been slow to adopt private market investments. In this article, we’ll discuss why the time is right for private market assets in TDFs — and how State Street is meeting this need for DC investors.

Why have Target Date Funds (TDFs) become the dominant option for over 80% of Defined Contribution plans? While important differences in approach exist across providers, the broader value proposition is simple — professionally managed, risk-aware, and low-cost exposure to the global public market opportunity set.

Meanwhile, private markets now make up a rapidly increasing percentage of overall markets. Over the last twenty years, private equity has increased from a modest 3% of the total equity market to over 10%.¹ Through a different lens, over 90% of companies in the United States are private. A similar trend has emerged in the rapidly growing private credit space — today making up nearly 7% of US Debt outstanding and over 20% of total credit markets.² This rapid growth has had a profound effect on markets — challenging the notion that a truly diversified portfolio can be built without considering private markets.

Defined Contribution plans have notably diverged in the adoption of private markets from other retirement segments, in the US and globally. The average US Defined Benefit plan, for example, features a 25% allocation to alternative asset classes, while the average US DC plan is less than 2%.³ Within the $3.5T Target Date market, we estimate only $115B is allocated to Target Date Funds with private equity and/or private real estate exposure.⁴

The reason for that exclusion to date has little to do with risk and return. Instead, concerns have largely focused on how the ‘daily valued’ and ‘daily traded’ nature of DC plans meant that the traditional private market fund may not be ‘fit for purpose.’ Historically, private market offerings have been structured as drawdown funds, which take time to hit allocation targets (due to capital call structures); offer very limited liquidity; and subject investors to “J-Curve,” where early investors are potentially disadvantaged by the time it takes to get a product to scale. Additionally, these funds tend to offer somewhat limited diversification because sector exposure dictates overall holdings. These issues were partially addressed by the emergence of ‘fund of fund’ structures — however, these structures often lack cohesion between approaches and create the potential for layered fees across multiple structures.

The emergence of evergreen funds — perpetual, semi-liquid vehicles that today have scaled to over $350 billion in assets⁵ across a range of private market asset classes — mitigates many of these historical concerns. For at-scale strategies, the potential for monthly subscriptions, quarterly redemptions, and no J-Curve makes for a compelling fit within the Target Date framework. Additionally, just 1% of Target Date investors traded during calendar year 2023,⁶ and the long-term orientation and steady inflows suggest that TDFs may be a good fit for private market offerings – especially as these offerings continue to evolve.

Focusing on the Details

While structures have come a long way, the nature of the exposure is crucial to align with participant objectives and time horizons. In the limited cases where private markets have been represented in DC plans today, it has come through direct real estate holdings. While the asset class offers the potential for strong risk-adjusted returns, it is typically diluted by an ample public-market liquidity sleeve and comes with considerable idiosyncratic liquidity risks if the asset class falls out of favor. The recent market environment for commercial real estate has led to prolonged periods of proration and a difficult experience for DC plans looking to make a plan-level change.

Expanding beyond private real estate (to include both core and traditional private equity, private credit, and broader private real assets) provides the potential for improved risk-adjusted returns, and the flexibility to focus on the total return of the portfolio, rather than have allocations dictated by sector. A fully scaled private market solution that is diversified across investments, investors, and vintage years provides the potential for an enhanced liquidity framework that is less susceptible to idiosyncratic risks. Through this work it is important to note that very different approaches exist across private markets. Long-term focus, downside protection and lower operating leverage are key features of what we view as an appropriate allocation for Defined Contribution investors when compared to higher-risk, highly levered strategies.

Target Date Lens

As we have managed target retirement funds for over 30 years across a variety of investment vehicles, geographies and investment opportunity sets, we have honed a glidepath philosophy ground in long-term participant objectives and a more thoughtful approach to risk management. While this process lends itself to the incorporation of private markets, we have previously applied this philosophy only through custom target date mandates. Today, evolution in market structure and private market offerings suggest that this approach is appropriate in a commingled offering.

Specifically, we are actively exploring a methodology built upon strategic asset allocation and index-based investing in public markets, paired with a diversified exposure to private markets across the glidepath. We believe this combination provides the potential for meaningful impact on participant outcomes due to higher long-term return expectations, lower expected volatility, and low correlation with public asset classes that private markets may offer.

The Bottom Line

We designed our approach to evolve as markets evolve, with a consistent focus on improving retirement outcomes for plan participants. Democratizing access to a broad range of private market exposures for DC plan participants is the next step in that evolution.