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The DC Door Opens for Private Equity

DOL outlines the conditions and due diligence processes that plan fiduciaries should consider when evaluating PE as part of a professionally managed asset allocation portfolio.

In early June, the Department of Labor (DOL) issued an information letter that discussed “the use of private equity investments in designated investment alternatives made available to participants and beneficiaries in individual account plans, such as 401(k) plans, subject to the Employee Retirement Income Security Act of 1974 (ERISA).”

The letter contained good news for private equity (PE) firms, including Pantheon Ventures and Partners Group, who queried the agency through their attorney. Essentially, the DOL outlined the conditions and due diligence processes that plan fiduciaries should consider when evaluating PE as part of professionally managed asset allocation portfolios like target date funds. The letter states: “In making such a selection for an individual account plan, the fiduciary must engage in an objective, thorough, and analytical process that compares the asset allocation fund with appropriate alternative funds that do not include a private equity component, anticipated opportunities for investment diversification and enhanced investment returns, as well as the complexities associated with the private equity component.”

Making the Case

The case for including alternatives, including PE, is that they increase portfolio diversification and improve longer-term results. David O’Meara, senior investment consultant with Willis Towers Watson, says that institutional investors in other parts of the world often have significantly greater exposures than their U.S. counterparts. For example, superannuation funds in Australia often have upward of 20% or more of assets in alternatives.

Third-party research has supported the case. In June 2018 the Georgetown University Center for Retirement Initiatives (CRI) published “The Evolution of Target Date Funds: Using Alternatives to Improve Retirement Plan Outcomes,” which discussed the products’ inclusion in TDF funds. From the report’s summary: “The strategic use of alternative assets in a TDF structure, or a diversified TDF, demonstrates that including these asset classes can improve expected retirement income and mitigate loss in downside scenarios.”

But that’s not a unanimous conclusion. A recent Wall Street Journal article, “The Mixed Case for Private Equity in Retirement Plans,” cites sources who argue that the dispersion in PE funds’ results and questions on the reliability of performance metrics make the case less clear-cut when the funds’ higher fees, reduced liquidity and lack of transparency are factored in. The WSJ article also mentions studies from Oxford University and Cambridge Associates that downplay claims that PE funds have substantially outperformed stock market indexes.


Assuming a plan sponsor wants to consider adding alternatives, what factors should be considered? A February 2020 CRI report, “Use of Alternative Assets in Target Date Funds: Challenges, Strategies and Next Steps,” reviewed potential hurdles to including alternatives. Among the challenges listed:

  • Adequate governance and oversight;
  • Liquidity and pricing requirements;
  • Fees;
  • Benchmarking; and
  • Legal risks to fiduciaries.

Pantheon Ventures first developed a PE fund for DC plans in 2012 and launched it near the end of 2013, according to Doug Keller, the firm’s head of private wealth and defined contribution. The fund was intended to serve as a sleeve in a target date fund or a similarly professionally managed asset allocation fund. He cites several of the challenges in designing the fund that coincide with the CRI list. “I would summarize the topics of operational and administrative obstacles into three buckets: an evergreen portfolio, daily pricing and daily liquidity,” he says. “And those three things are not very typical to private equity, but it is those things that we have addressed through product development.”

Josh Cohen, head of institutional defined contribution at PGIM, shares a comparable assessment. “Whether it's private equity or any of the more illiquid asset classes, including things like real estate, maybe even some hedge funds, the two biggest issues you always have to worry about are: 1) pricing; and 2) liquidity,” he says. “From the pricing perspective, the way the DC environment works is, rightly or not, we need to provide a daily value to the investments that individuals have.”

Sponsors’ concern over litigation was another primary concern, Keller adds, and although the DOL letter was just published, he reports that sponsors have welcomed the guidance. For at least some plans, the guidance should be the linchpin that allows plans to seriously consider adding PE.

Looking Ahead

The DOL’s letter should provide momentum to the ongoing shift among DC plan sponsors to adopt a more institutional-investment approach, Cohen believes. “The letter did specifically address private equity because that's what was asked of them,” he says. “But I think it's an opportunity to have a broader discussion with plan sponsors about a thoughtful institutional approach looking at myriad asset classes, not just private equity.”

The availability of pooled employer funds, particularly those offered by independent fiduciaries, starting next January also could boost interest in the nontraditional asset classes, says O’Meara. “We expect that some of those pooled employer plans will likely have alternative investments in their solutions to some degree,” he says. “That may then help spur change within the employer/sponsor defined contribution market as a guidepost to see what is within the realm of possibilities.”

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