Diversified portfolios that incorporate private equity funds consistently have higher portfolio returns and higher return per unit of risk, according to a new white paper sponsored by Northern Trust.

The paper, Why Defined Contribution Plans Need Private Investments, is based on recent research from the Institute for Private Capital (IPC) and the Defined Contribution Alternatives Association (DCALTA) analyzing the viability of replacing a portion of public equity allocations with private markets investment in diversified and time-varying portfolios.

Using a database of more than 2,500 US private equity funds, the research study simulated historical performance of diversified portfolios that include allocations to private fund assets. The research concluded that investing in private funds always increases average portfolio returns and reliably increases Sharpe ratios (return per unit of risk).

Says Serge Boccassini, Senior Vice President of Institutional Global Product and Strategy at Northern Trust and Research Chairman of the DCALTA Board: "Private assets such as private equity, real estate, infrastructure and hedge funds have experienced significant growth since the 1980s to a total of roughly $6 trillion in committed capital today. They provide the benefit of diversification through low correlation to traditional asset class performance in DC investment portfolios,"

Traditional portfolio management methods currently offer very limited asset allocation and portfolio optimization guidance when involving alternative assets, notes Northern Trust. It says the paper outlines potential return characteristics and diversification benefits and offers allocation strategies to guide investors in making better investment decisions.

The research results further show that while portfolios benefit overall from investing in private assets, the extent of the benefit depends on the type of private investment, it adds.

"Northern Trust is a global provider of defined contribution services," said Boccassini. "In looking at the Australian market as an example, participants have a unique advantage because of their ability to invest in private capital.

"The US would benefit from a transition from a supplemental DC savings mindset to a long-term, compensation replacement mindset which includes institutionalizing DC investments to be more like DB investments. The research presented in this paper makes it clear that including private assets as an option in DC plans is instrumental to this transition."

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Diversified portfolios that incorporate private equity funds consistently have higher portfolio returns and higher return per unit of risk, according to a new white paper sponsored by Northern Trust.

The paper, Why Defined Contribution Plans Need Private Investments, is based on recent research from the Institute for Private Capital (IPC) and the Defined Contribution Alternatives Association (DCALTA) analyzing the viability of replacing a portion of public equity allocations with private markets investment in diversified and time-varying portfolios.

Using a database of more than 2,500 US private equity funds, the research study simulated historical performance of diversified portfolios that include allocations to private fund assets. The research concluded that investing in private funds always increases average portfolio returns and reliably increases Sharpe ratios (return per unit of risk).

Says Serge Boccassini, Senior Vice President of Institutional Global Product and Strategy at Northern Trust and Research Chairman of the DCALTA Board: "Private assets such as private equity, real estate, infrastructure and hedge funds have experienced significant growth since the 1980s to a total of roughly $6 trillion in committed capital today. They provide the benefit of diversification through low correlation to traditional asset class performance in DC investment portfolios,"

Traditional portfolio management methods currently offer very limited asset allocation and portfolio optimization guidance when involving alternative assets, notes Northern Trust. It says the paper outlines potential return characteristics and diversification benefits and offers allocation strategies to guide investors in making better investment decisions.

The research results further show that while portfolios benefit overall from investing in private assets, the extent of the benefit depends on the type of private investment, it adds.

"Northern Trust is a global provider of defined contribution services," said Boccassini. "In looking at the Australian market as an example, participants have a unique advantage because of their ability to invest in private capital.

"The US would benefit from a transition from a supplemental DC savings mindset to a long-term, compensation replacement mindset which includes institutionalizing DC investments to be more like DB investments. The research presented in this paper makes it clear that including private assets as an option in DC plans is instrumental to this transition."