Private capital in 401(k)s: What plan sponsors should know

Private capital in 401(k)s: What plan sponsors should know

Are private capital investments a fit for defined contribution plans?

Is adding private capital investments to a 401(k) trying to fit a square peg in a round hole? This is a question many defined contribution plan sponsors should be thinking about regarding private capital.

Private capital, primarily private equity, private credit and private real estate, refers to investments outside publicly traded markets. Instead of exchange-traded stocks, bonds or real estate securities, these strategies invest directly in private companies, loans and physical real estate assets.

While interest in private capital is growing rapidly, the reality of investing in it is more complex. For plan sponsors, the decision to incorporate private capital into a 401(k) lineup comes with meaningful considerations, especially around fiduciary responsibility, transparency and participant outcomes.

Why private capital is gaining momentum in 401(k) plans

Over the last two years, the 401(k) industry has witnessed a large push to integrate private capital investments into its sizeable asset pool. This has come in the form of:

• a presidential executive order to expand access and remove regulatory barriers;

• regulatory steps from the SEC and DOL to loosen investment requirements and provide cover for fiduciary decisions; and
• a surge of new products, partnerships and marketing campaigns that include accommodative target‑date strategies as well as advisor‑led and recordkeeper-led programs designed to facilitate private‑capital adoption in participant accounts.

Many of these solutions are being introduced through:

• target-date funds with private capital exposure;

• recordkeeper and advisor-led programs; and

• structured portfolio solutions within participant accounts.

Despite this momentum and attention, adoption is not without challenges. Specifically, private capital investments carry potential investment and non-investment risks for 401(k) plan sponsors. For example, compared to traditional investment options in today’s 401(k) plans, performance of private capital investments can be hard to measure against widely recognized and transparent benchmarks like public stock indexes, applicable bond indexes, e.g., high yield bond, and balanced indexes composed of stocks and bonds.

The difficulties in measuring and comparing private capital performance to other markets include the performance metrics themselves, as well as the timing of the reported metrics. Performance details can rely on assumptions, be opaque and have delayed reporting.

Risks of private capital investments in 401(k)s

Compared to traditional 401(k) investment options, private capital introduces both investment and operational complexities.

1. Limited transparency and benchmarking challenges

Unlike public market investments, private capital performance can be difficult to measure against widely recognized benchmarks such as:

• public equity indexes;

• bond indexes (e.g., high-yield bonds); and

• balanced portfolios.

Performance reporting may:

• rely on assumptions;

• be less transparent; and

• be reported with delays.

This creates challenges for fiduciaries who must evaluate and justify investment decisions.

2. Performance measurement and comparisons

Private capital vs. public stock and bond market returns are often presented using different methodologies, including:

• Internal Rate of Return (IRR);

• return multiples (e.g., 1.10x); and

• total returns.

These variations can make “apples-to-apples” comparisons with public markets difficult (and potentially misleading).

3. Fee complexity

Private capital investments may include:

• management fees; and

• performance (incentive) fees.

Key considerations include:

• how performance fees are calculated; and

• whether these incentive fees are assessed position by position or based on the total allocation’s performance.

After examining this, it’s also important to ask yourself: Can incentive fees be collected (position by position) even if the overall allocation underperforms? This is because fee disclosure and clarity are critical for fiduciary oversight.

4. Liquidity constraints

Unlike daily liquid mutual funds, private capital investments may have:

• lock-up periods;

• delayed redemption timelines; and

• restrictions on participant transfers or distributions.

This can create complications within a 401(k) plan structure designed for liquidity and flexibility.

Critical questions for plan sponsors

Before adding private capital to a 401(k) lineup, plan sponsors should evaluate several key areas:

Investment fit and diversification

• Are the private capital returns you are evaluating truly complementary to existing plan investments?

• Are diversification benefits clear, consistent and substantiated?
  
  

Performance and benchmarking

• How often are the private capital investments valued (“marked”) to derive performance?

• How are they valued (“marked”) and what assumptions are used in the valuation?

• Are return comparisons provided between private capital investments and public comparables, such as large cap stocks, high yield bonds and real estate securities?

• If comparisons are provided, confirm if the return measures used are uniform or like to like, such as total returns or return multiples (e.g., 10% gain equals a 1.10X multiple).

• If not, confirm how the private capital investments’ performance is calculated, such as an internal rate of return (IRR).

• After confirming these items, are diversification benefits or outperformance of public comparables clear, consistent and substantiated?
  
  

Fees and cost transparency

• Verify if there are management and performance fees with the private capital investments you’re evaluating.

• If there are management and performance fees, understand how both are calculated and collected. For example, are the performance fees collected deal by deal (position by position), or based on the total private capital allocation’s performance. In other words, can performance fees still be collected on individual private capital holdings (one company, one loan or one property) regardless of whether the total allocation of all private capital holdings has generated a gain or value-add for participants?

• Are fees clearly disclosed and understandable?
  
  

Plan integration

• How will private capital investments be included in the plan’s investment lineup, e.g., target-date series or advisor-driven portfolios?

• How will this affect overall plan design and risk exposure?
  
  

Participant understanding and education

• Will participants understand these investments?

• What education and communication will be provided?
  
  

Reporting and oversight

• Is reporting transparent and timely?

• Can performance or underperformance be clearly explained to the governing committee?
  
  

Liquidity and access

• What are the liquidity provisions?

• Could participant transactions be delayed under certain conditions?

Fiduciary risk and legal considerations

The retirement industry has seen a rise in litigation. Introducing complex, less transparent investments like private capital can potentially increase fiduciary exposure.

Until there is clearer regulatory guidance and broader industry standards, plan sponsors must carefully weigh:

• participant benefit vs. complexity;

• innovation vs. risk; and

• access vs. oversight.

As mentioned earlier, for many, private capital in 401(k)s may still feel like trying to fit a square peg into a round hole.

Private capital vs. other alternative investments

It’s important to note that private capital represents just one segment of the broader alternative investment universe.

Other strategies, such as liquid alternative mutual funds, offer:

• daily liquidity;

• greater transparency with daily performance; and

• institutional-level diversification.

These strategies have long been used in:

• defined benefit (pension) plans; and

• institutional portfolios.

And may provide a more practical entry point for defined contribution plans seeking diversification and downside risk management strategies.

Main takeaway

Private capital investments may offer potential benefits, but they also introduce complexity that doesn’t naturally align with the structure of most 401(k) plans.

For now, plan sponsors should approach with:

• careful due diligence;

• strong governance processes; and

• clear participant communication.

Until the industry evolves further, thoughtful evaluation remains essential.

Remember: private capital investments are only some types of non-traditional (alternative) investments. The alternative investment industry has an immense amount of strategies that can and will vastly differ from each other.

This includes liquid alternative investment strategies already available in mutual fund structures that can be used to pursue various investment objectives, most notably, diversification and downside risk management, that have typically been used in defined benefit plans (pensions) and other institutional investment portfolios.

Learn more

For a deeper look at how alternative investments can enhance diversification and long-term returns, explore our full report.

To discuss how alternative investments may fit into your retirement plan or institutional portfolio, contact TruePlan.