Private equity investments are virtually non-existent within 401(k)s, and recent hype from regulators might do little to change that.
On Wednesday, the Department of Labor published a letter in response to Pantheon Ventures, clarifying that private equity is indeed allowed to be used within defined-contribution plans as part of a multi-asset investment strategy, such as a target-date product.
Accompanying that letter were statements from Labor Secretary Eugene Scalia and Securities and Exchange Commission Chairman Jay Clayton, both touting the potential for private-equity investments.
But the letter to Pantheon did not outline safe harbor protections for plan fiduciaries — it largely confirmed what plan consultants already knew, which is that the Employee Retirement Income Security Act does not prohibit such investments.
A plan fiduciary would not violate ERISA “solely because the fiduciary offers a professionally managed asset allocation fund with a private-equity component,” according to the DOL letter.
“There’s nothing in ERISA that prohibits private equity in a DC plan, as an asset class,” said James Veneruso, defined-contribution consultant at Callan. “To me this wasn’t any sort of a game changer. This wasn’t a change in the rules.”
In order to include investments with a private-equity component, fiduciaries simply need to follow a product process and document it, he noted.
It’s a market that private-equity firms have long coveted. The Blackstone Group, for example, purchased Aon Hewitt’s retirement plan record keeping business in 2017, later rebranding it as Alight Solutions. Blackstone CEO Stephen Schwarzman described the inclusion of private equity in 401(k) plans as a “dream.”
But a big hurdle is asking plan sponsors to add complexity and cost to their investment options, which can make private equity a difficult sell. And DC plan sponsors, ever leery of being sued, are not keen to be the first penguin to jump off the iceberg.
“For run-of-the-mill business owners, even some of the largest plans we serve, they don’t want to stand out,” said Jason Roberts, CEO of the Pension Resource Institute. “They want to get [a plan], do what’s right by their employees, but they don’t want to stick their necks out. And it would take [private equity] getting a foothold in the large plan market and trickling down.”
When 401(k) plans make changes to their investment menus, sponsors do so in order to improve outcomes for their participants, Veneruso said.
Adding alternative investments, or strategies that include alternatives, can be prudent, but sponsors want to be able to show that any increase in cost or complexity will be rewarded in the form of higher returns or long-term performance, he said.
“There’s a very big asymmetric payoff, if you go out on a limb and try something new. And if it’s a success, that’s good. But seldom is a plan participant going to call you up and thank you,” he said. “If things don’t go well, there is the risk of a lawsuit. There is career risk.”
For the past five years, Intel has been fighting a lawsuit over the use of private equity within its 401(k) plan. Earlier this year, the U.S. Supreme Court found that Intel could not be granted summary judgment because of a three-year limit for plaintiffs to bring claims, after being provided with investment disclosures. That case has not been decided on its merits.
“We work with quite a few custom clients. We do not have any using [private equity],” Veneruso said.
Only about 1% of large plans surveyed by the Defined Contribution Institutional Investment Association said their custom target-date options include private equity, according to a report from the organization in May. Those target-dates use private equity as a diversifier, along with other investments like bank loans or hedge funds, and they represent only a small proportion of a target-date’s assets — typically less than 1%, according to the DCIIA report.
“The prevalence of private equity in custom target-date funds is quite low,” said Christopher Nikolich, an author of the report and U.S. head of glide path strategies for multi-asset solutions at AllianceBernstein. “However, I do expect to see more private equity in custom target-date funds over time.”
AllianceBernstein manages custom retirement plan portfolios that include private equity, Nikolich said. Allocations can vary from about 5% to 15%, he said.
“Custom target-date funds will be managed more like sophisticated multi-asset-class portfolios [in the future],” he said. “The [DOL] guidance and the letter will only help … to be a catalyst to help those exposures grow over time.”
Private equity can help boost returns, as the amount of privately-listed companies has been increasing, he said.
Clients “see the potential for long-horizon growth that may be above and beyond what you see in public equity markets,” he said. “That growth becomes more important in an environment where equities may not deliver double digit returns every year.”
Custom target-date funds, such as the one at the heart of the Intel lawsuit, are generally used within very large DC plans, or those with billions of dollars in assets. AllianceBernstein, which was not named in that lawsuit, had been the target-date series manager.