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June 15, 2020 12:00 AM

DOL opens gate to private equity in DC plans

Big rush to add the asset class is not expected, experts say

Brian Croce
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    Department of Labor building, Washington
    Bloomberg

    Experts don't expect plan sponsors to immediately begin offering private equity investments following the Labor Department's recent ruling.

    After years of calls from alternative asset proponents, the Department of Labor has explicitly permitted the use of certain private equity strategies in defined contribution plans so long as a prudent fiduciary process is undertaken.

    But while the Labor Department's guidance is a step in the right direction, the adoption of private equity in DC plans won't happen overnight, experts say.

    "We do think the marketplace is there," said Robert Collins, managing director and head of Partners Group (USA) Inc.'s New York office. "Now does it change in July 2020? No, this is still an institutional marketplace that has a deliberate and methodical way of introducing products … so it will take some time. It's not today, tomorrow, or next month, but we're convinced that this is the action that the DOL needed to take in order for these sponsors to finally be able to achieve their objective of offering that best-in-class portfolio, which gives their employees a better chance at hitting their goals."

    Robert Collins said the institutional market is methodical, so implementation will take some time.

    The Labor Department published an information letter June 3 in response to a Groom Law Group LLP request on behalf of its clients Pantheon Ventures (U.S.) LP and Partners Group, which have developed private equity strategies that can accommodate DC plans. The letter made clear that DC sponsors can implement certain private equity strategies into diversified investment options, such as target-date, target-risk or balanced funds, while complying with the Employee Retirement Income Security Act.

    It also outlined the steps a fiduciary must take when evaluating the risks and benefits associated with the investment alternative. In order to comply with ERISA, the Labor Department said a fiduciary should consider whether the allocation would offer plan participants the opportunity to invest their accounts among more diversified investment options within an appropriate range of expected returns net of fees; how the allocation fund is managed; and whether the allocation fund has limited the allocation of investments to private equity in a way that addresses potential cost, complexity, disclosures and liquidity issues.

    Jonathan Epstein, New Orleans-based president of the Defined Contribution Alternatives Association who has spoken with Labor Department officials about the merits of these assets, applauded the guidance and said it is "helping plan fiduciaries give participants access to investment products that had previously been limited to institutional investors."

    While private equity investments have long been incorporated in defined benefit plans, DC plan sponsors have mainly steered clear of incorporating alternative assets in their plans due to litigation concerns and structural issues such as liquidity and valuation needs.

    Pantheon and Partners Group say they solved for the latter concern with private equity investment products containing a liquidity component to manage participant-directed deposits and withdrawals.

    Pantheon, which established a collective investment trust in 2013 that's intended to be incorporated within a target-date fund, has pension fund assets within it, but not DC plan assets at this point, a spokeswoman said, though declining to provide specifics.

    Partners Group started its own CIT in 2015, which currently has no DC assets but does have two defined benefit plans — one public, one corporate — using the product, Mr. Collins said, though he declined to provide specifics.

    Allocations to diversifiers, which include alternative assets, currently make up a small percentage in custom target-date funds — 0.7% on average in both target years 2020 and 2060 funds, according to research from the Defined Contribution Institutional Investment Association published in May.

    Safe from litigation?

    Following the Labor Department letter, plan sponsors' litigation concerns should be eased when considering adding private equity to their portfolios, said Doug Keller, New York-based head of private wealth and defined contribution at Pantheon. "The key ask was 'is private equity permissible under the law?'" Mr. Keller said. "We suggested they provide a framework and we're glad they did."

    David O'Meara, a New York-based senior defined contribution strategist at Willis Towers Watson PLC, said the letter should help plan sponsors respond to lawsuits. "If they are following the process laid out by the Department of Labor, it's hard to fault them with making what (could) arguably (be) a wrong decision," Mr. O'Meara said.

    Nevertheless, many plan sponsors will take a "wait-and-see" approach, said Will Hansen, chief government affairs officer at the American Retirement Association and executive director of the Plan Sponsor Council of America in Washington, in an email.

    "Time will tell whether this becomes yet another copy-and-paste lawsuit from the plaintiffs bar," Mr. Hansen said. "Plaintiffs lawyers are bringing lawsuits against plan sponsors if they sneeze in the wrong direction (or if they provide too many funds, too few funds, issues with fees, etc.). I could envision a lawsuit if the fees associated with the fund that contains private equity are higher than another fund even if that fund was performing better."

    In recent years, plan sponsors have been hit with class-action lawsuits centering on excessive fees. Notably, a lawsuit against Intel Corp. reached the Supreme Court, whose ruling in February gave DC plan participants more time to file ERISA claims unless they have "actual knowledge" of the sponsor's investment decisions and actions. The 2015 lawsuit alleged that plan managers violated their ERISA fiduciary obligations by offering too many alternative investments and inadequate disclosures of investments.

    Dennis Simmons, executive director of the Committee on Investment of Employee Benefit Assets in Washington, said in a statement that the issuance of the Labor Department letter "will further encourage DC plan investment committees to have thoughtful conversations about the diversification and enhanced potential return merits of using alternatives, and not be unduly distracted by the perception of increased litigation risk."


    Floodgates not opening

    Charles P. Nelson, Windsor, Conn.-based CEO of retirement and employee benefits for Voya Financial Inc. and a Defined Contribution Alternatives Association board member, said with the declining number of public companies, it's important to give retirement savers access to private markets. And while Voya target-date funds do not currently include any alternatives, Mr. Nelson said the Labor Department guidance "may lead some plan sponsors to have a greater comfort to include those and that's why we're excited about this letter."

    Mr. O'Meara said he doesn't expect the floodgates to open in terms of private equity adoption in DC plans, but he does expect more plan fiduciaries to evaluate the asset class. Moreover, while the Labor Department letter was specific to private equity, "the process that the DOL walks through is broadly applicable to practically any investment that a fiduciary would determine to implement in the defined contribution plan, so whether that be real estate or private credit or hedge funds … this letter lays out a prudent fiduciary process to follow," he said.

    Michael Falk, Chicago-based partner at Focus Consulting Group Inc., cautioned fiduciaries from embracing the asset class too quickly. "I'm not going to stand on a soap box and say 'PE is evil.' I think it has a functional space in society; however, the costs can be so large and anything but transparent," Mr. Falk said.

    Labor Secretary Eugene Scalia said in a news release, which also included an endorsement from Securities and Exchange Commission Chairman Jay Clayton, that the guidance will help Americans better save for retirement. "The letter helps level the playing field for ordinary investors and is another step by the department to ensure that ordinary people investing for retirement have the opportunities they need for a secure retirement," Mr. Scalia said.

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