Modernizing retirement plans with alternative investments

The rising interest in private market investments may be a sign of significant change on the horizon for the workplace retirement savings industry.

With the estimated $24 trillion invested in private market capital in the United States expected to rise, how will the private market impact retirement plans?¹

When mutual funds first came onto the scene in the post-World War II era, they transformed the way average Americans accessed the stock market. Before that, investing in stocks was largely reserved for the wealthy, leaving the rest of the population with few opportunities to grow their nest egg through the market. Mutual funds changed all of that by allowing everyday people to pool their money together, gaining access to a diversified portfolio of stocks, bonds, and other securities. This democratization of investing was revolutionary, leading to massive wealth creation for millions of "Main Street" Americans.

Today, only about 5% of US households have private market investments. At Franklin Templeton, we see a parallel between that historic shift and the current opportunity to bring private market investments—such as private equity, private credit, and private real estate—into defined contribution (DC) plans like 401(k)s.

We envision a future where all retirement investors, particularly those previously limited to public markets, have access to a broader share of global capital markets. Our firm’s leaders had a similar vision 80 years ago, and we are committed to pioneering the widespread adoption of private market assets within defined contribution (DC) plans.

Just as mutual funds opened the door to the stock market for the average investor, we believe that private market assets can offer a new frontier of investment opportunities, helping to drive better retirement outcomes for millions of hard-working Americans.

As Mark Twain once said, "History doesn’t repeat itself, but it often rhymes." The shift we’re seeing today mirrors the way mutual funds democratized stock market investing in the mid-20th century. Now, it's private markets that are becoming the new frontier.

The proliferation of mutual funds: Supports wealth creation and the economy!

In the aftermath of World War II, the US economy was on the rise, and with it came an increased interest in the stock market. However, Wall Street was largely the domain of the wealthy and well-connected. Individual stocks were expensive, and many people lacked the resources, knowledge or confidence to participate in the market. Enter the mutual fund—a simple, yet powerful investment vehicle that pooled money from many investors to buy a diversified portfolio of stocks, bonds, or other securities— all managed by a professional.

Mutual funds made it possible for everyday Americans to invest in the stock market with small amounts of money. They offered professional management, diversification to potentially reduce risk, and the ability to buy into a portfolio that would otherwise be out of reach for individual investors. This democratization of investing opened the doors for millions of Americans to build wealth through the stock market, contributing significantly to the growth of the middle class and the overall economy.

Over time, mutual funds became a cornerstone of retirement planning. Employer-sponsored 401(k) plans, which started gaining popularity in the 1980s, often featured mutual funds as the primary investment option. This made it easy for employees to contribute a portion of their salary to a diversified investment portfolio, setting the stage for long-term wealth accumulation. Today, mutual funds manage trillions of dollars in assets, and they remain a key tool for retirement savings for millions of Americans.

What are private market investments?

Private market investments include assets like private equity, private credit and real estate that aren't traded on public exchanges. Historically, these investments have been available only to wealthy individuals and large institutions. They offer opportunities to invest in companies and projects before they go public, and can lead to higher potential returns.

Imagine being able to invest in a promising company or real estate project early on and watching your investment grow significantly over time. That's the potential power of private market investments.

A shrinking public market and a growing private one

It’s important to recognize the landscape of investing is changing. Over the past decade, the number of publicly traded companies in the United States has been steadily decreasing. In fact, since 2000, the number of US public companies has dropped by 27%, according to McKinsey & Co. This trend suggests that more companies are choosing to remain private longer (or forever), which creates a bigger gap in investment opportunities for investors. The investible universe in private markets is simply much larger than public markets. For example, only 13% of US companies with over $100 million in revenue are public, excluding many investors from some 19,000 private companies.²

Private markets assets under management totaled $13.3 trillion in 2023, according to PwC.³ Assets in private markets grew roughly 8% per year over the past five years, the report noted.

We believe without access to private market investments, investors have limited options in capital markets, resulting in missed opportunities for portfolio diversification and alternative sources of risk and return.

Note: Hypothetical 18-year portfolio return with and without alternative investments as of 12/31/2023. For illustrative purposes only. Hypothetical portfolio results shown do not represent the performance of an actual investment. Stocks, bonds, private equity, private credit, private real estate, and hedge funds are respectively represented by the S&P 500 Index, Bloomberg U.S. Aggregate Bond Index, Burgiss US Private Equity Funds Index, Cliffwater Direct Lending Index, NFI-ODCE Index, HFRX Equity Hedge USD Index, HFRX Global Hedge Fund USD Index, HFRX Macro/CTA USD Index. Please note that an investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges. Diversification does not assure a profit or protect against market loss. All investments involve risk, including loss of principal. Past performance is no guarantee of future results.

To explore hypothetical example in more detail, see our resources, Alternatives By Ft.
 

Why does this matter for your 401(k)?

With fewer public companies available to invest in, sticking solely to traditional public market assets might limit growth potential. Private markets, on the other hand, have shown consistent, strong returns, especially in the period from 2016 through 2023.⁴ These investments also offer an avenue for diversification that isn’t as readily available in the shrinking public markets. By incorporating private market investments into 401(k) plans, we can provide hard working Americans with access to these lucrative opportunities that were previously reserved for large institutions and the wealthy.

Many individual investors miss out on early-stage growth

The trajectory of early-stage growth often dwarfs that of more mature companies. Private equity investments participate in this stage of a company’s development.