On Wednesday, June 3, 2020, the Employee Benefits Security Administration of the US Department of Labor (“DOL”) issued guidance concerning the ability of 401(k) and other defined contribution plan (“DC plan”) fiduciaries to prudently offer exposure to private equity strategies as an option to plan participants. In an information letter responding to a request by Patheon Ventures L.P. and Partners Group, Inc. for clarity on the use of private equity investments in DC plans subject to ERISA, the DOL provided a framework of important factors for plan fiduciaries to consider when evaluating whether to incorporate private equity. The guidance relates specifically to the inclusion of private equity as an underlying component in a professionally managed asset allocation investment vehicle, such as a target date, target risk, or balanced fund. While the direction provides for permissible use of an investment alternative with exposure to private equity, as well as other publicly traded securities or other liquid investments, it does advise “in no case would the private equity component of the asset allocation fund be available as a vehicle for direct investment by plan participants and beneficiaries on a stand-alone basis.”
While private equity has long been incorporated in defined benefit plans, DC plan sponsors have typically avoided the asset class due to the prospect of liability under ERISA. Reservations relate to private equity’s high fees, lack of liquidity, and typically, complex structure. But the DOL’s letter intended to alleviate some of those concerns and assure DC plan sponsors that “private equity may be part of a prudent investment mix.” The guidance comes at a time when many American families are struggling to save, and provides retirement plan participants with access to alternative investments that may enhance returns and diversification compared to a portfolio invested to solely in the public market, as well as provide a hedge against volatility in the public markets.
In order to prudently assess and select an investment alternative with a private equity component, the DOL guidance identifies the following considerations: (a) the impact of the allocation to private equity on the plan investment option’s diversification and expected returns net of fees; (b) the capability of the plan fiduciaries to evaluate and monitor private equity investments, and whether the plan would be better served by a discretionary investment advisor; (c) the weight of the allocation to private equity within the plan investment option; (d) whether the liquidity and valuation features of the investment option will enable participants to take distributions and exchange into other plan investment options at their desired frequency ; and (e) the ability of participants to independently evaluate the investment option with a private equity component based on provided disclosures and information. Nothing in the DOL guidance requires plan fiduciaries to incorporate private equity strategies in their plans, but, in its own terms, the letter is “another step by the department to ensure that ordinary people investing for retirement have the opportunities they need for a secure retirement.”
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Author: Jonathan Dilger