11 Oct 2023 5 min read

Sizing private markets in DC

By John Southall , Jesal Mistry

How much should DC investors invest in illiquid assets? We consider the potential benefits of an allocation to private markets.


We believe there are two main reasons illiquid assets may deserve an allocation in DC portfolios:

  • Diversification[1]: they allow access to a broader opportunity set
  • A potential source of outsized returns, either from illiquidity premia or lower market efficiency, leading to increased scope for skilled managers to add potential value

As many DC investors have investment horizons that stretch out for decades, they may be well placed to capture illiquidity-based return potential. There are, of course, grounds for caution.

Diversification is often viewed as a ‘free lunch’, but potentially outsized returns are not. Apart from reduced liquidity, private assets suffer from scant historic data, a lack of transparency, and difficulties in measuring their returns. Rebalancing is constrained, costs higher and governance requirements more onerous.

That sounds negative, but the aim of this blog isn’t to disparage private assets. We use our modelling frameworks to explore how much it might make sense for DC savers to invest.

Market cap

A useful starting point for asset allocations is the market capitalisation of the global investible universe. This indicates how the average investor chooses to split their assets. Estimating the proportion of investible assets that are private is tricky, but various studies point to figures around the 10% mark[2], with the share predicted to grow rapidly.

Square one might therefore be to hold around 10% in private assets. However, a particular investor may wish to adjust their strategy depending on their risk appetite, circumstances and beliefs. If they’re better placed, as many DC investors are, to harness illiquidity-based return potential, they might wish to hold a greater proportion.

A stronger belief in the pros of private assets outweighing their cons would also encourage a higher allocation. Finally, appetite for risk matters – for example, a long-term strategy focused on aggressive growth may be comfortable with a high allocation to private equity.

But can we quantify any of this?

Model making

To model the risk of private assets we employ a variety of approaches that we don’t go into here. For net returns (i.e. returns after typical costs), our starting point is to set excess return estimates in line with how much risk they add to the globally diversified market portfolio.

The nice thing about doing this is that the market portfolio is then the highest Sharpe ratio strategy, by construction. This means that if an investor has the same circumstances, beliefs and risk appetite as an average investor then they should hold 10% in private assets, neatly tying in with the idea above.

Of course, nobody is the average investor! As such want to understand how their strategy should differ. For the purposes of this blog, we consider five strategies:

  • Global listed equity
  • A liquid multi-asset diversified growth strategy (including listed equity)
  • Private equity (including venture capital)
  • Diversified private markets, including private equity but also private debt, real estate, infrastructure and sustainable resources
  • ‘Low-risk’, liquid assets: think cash, gilts and linkers depending on objective

Below we show efficient frontiers for combining these strategies. In the first chart we’ve assumed the investor is average other than a potentially different risk appetite.



In the second chart we’ve allowed for an additional 0.5% p.a. on private assets. This addition could reflect a greater ability to harness illiquidity-based returns, a stronger belief in the merits of private investing, or the ability to access private returns at lower costs. Note it’s not saying there is ‘only’ an illiquidity premium of 0.5% p.a. – rather it is saying that the benefits less the drawbacks of private assets are worth 0.5% p.a. more to this investor than the average investor.

As you can see, depending on preferences, a modest (c.10%) up to a very sizeable (c.40%) allocation to diversified private markets appears efficient if the overall volatility target is 10% p.a. At lower risks private assets are squeezed out, but at higher volatility private equity kicks in as a way of accessing higher expected returns.

A deduction, rather than addition, of 0.5% p.a. on private assets could make sense for DC investors with shorter time horizons. This eliminates private market exposure from the efficient frontier other than for very high return targets. As is typical, the optimisation is sensitive to return estimates.

Wider benefits

Compelling narratives and the potential wider societal benefits of some private assets can help people remain invested and engage with their pension.

There may also be psychological benefits to private assets. Appraisal-based valuations are often criticised as making private assets appear less risky than they really are. When exploited this is sometimes called ‘volatility laundering’. However, this feature has a positive dimension as it could help investors avoid succumbing to loss aversion.

Investors also tend to perceive tangible investments, such as property, as less risky.

Broadening the opportunity set

No strategy is all things to all investors and private markets are no different, so it is right to be cautious. However, we do think they can be a useful diversifier, at least in modest amounts. Although care is needed, it is also plausible that they offer illiquidity premia and alpha opportunities net of costs.

The potential benefits of private assets are particularly useful where they align with the opportunities and goals of the investor, for example a long horizon, resource to do the necessary due diligence and scale to negotiate lower fees.


[1] It should be noted that diversification is no guarantee against a loss in a declining market.

[2] One approach is to use the proportion of AuM that’s private as a proxy. For example, in 2021, PwC projected private markets would make up more than 10% of global AuM by 2025. Another approach is to consider the global investible universe directly. SSGA estimated 9% of the global investible universe of $179trn was in real estate and private equity as at the end of 2021.

John Southall

Head of Solutions Research

John works on financial modelling, investment strategy development and thought leadership. He also gets involved in bespoke strategy work. John used to work as a pensions consultant before joining LGIM in 2011. He has a PhD in dynamical systems and is a qualified actuary.

John Southall

Jesal Mistry

Head of DC Investments, Governance and Proposition

Jesal is Head of DC Investments, Governance and Proposition within L&G's DC team, working with advisers and their clients to help them access the best of L&G, i.e. a DC arrangement which delivers to an employer's and individual's needs, not just now, but always. Jesal joined L&G in June 2019, having spent 14 years as a DC consultant, specialising in DC scheme design, review and comparison of DC arrangements and DC investment strategy.

Jesal Mistry