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How private equity will be weaved into 401(k)s after government blessing

Because of the greater sophistication necessary for private equity investing, what’s not likely any time soon is that individual investors will be able to directly invest in a private equity fund as a standalone product.

The US Department of Labor gave its blessing to retirement plan administrators to include private equity as part of their defined contribution mix, a move for which the industry has been waiting a long time. 

The first “regular people” who will get the ability to access private equity will likely be workers who are part of customized defined contribution programs at large corporations. Such programs already have experience in the asset class through their traditional pensions, sources told me this week.

Customized defined contribution plans, which differ from standardized “off-the-shelf” products, are set up by large companies either internally or with external help.

Those pensions have a comfort level with private equity and their investment managers have been clamoring to get private equity into their defined contribution programs, sources said. 

Further, as corporations move away from traditional pensions, they seek to offer workers the best chance to make high returns to secure their retirements. 

That’s where private equity comes in, though along with the potential for higher returns come higher fees and risk. Adding private equity to 401(k)s present additional challenges outside of private equity’s normal experience, including the need for daily liquidity and daily pricing transparency.

Because of the greater sophistication necessary for private equity investing, what’s not likely any time soon is that individual investors will be able to directly invest in a private equity fund as a standalone product, the sources said. 

Instead, private equity access would be offered as part of a diverse investment mix in a defined contribution structure, where an individual investor would be able to choose their level of exposure to the asset class, sources said. 

“The guidance speaks to how private equity would be used in these professionally managed portfolios. That’s a key point, in that you have this fiduciary oversight in how these portfolios are constructed, not at the individual employee’s discretion,” said Robert Collins, managing director at Partners Group who lead the US distribution business. 

Partners Group and Pantheon both have products structured as investment trusts that plan sponsors can use to build private equity exposure into their programs. These would be incorporated into target-date funds as investment sleeves.  

Partners Group, for example, has the Partners Group Generations Fund for the UK defined contribution pensions market. Generations Fund provides participants with access to private equity, private debt, private infrastructure and private real estate, with daily liquidity and pricing, according to a statement from the firm.

Target-date funds structure investment allocation depending on when a worker will likely retire. Such structures include more risk for newer workers, and more conservative allocations for those nearing retirement. 

“The way that will look in the future, if you have a 2025 target date fund, you’d have relatively low or modest exposure to private equity, probably something around 1 percent or less,” according to Doug Keller, head of private wealth at Pantheon. 

A 2075 target date fund “will have the highest allocation, and in between will be varied. Those allocations would be up to whoever manages those target date funds,” Keller said. 

Plan administrators had been reluctant to include risky investments like private equity and hedge funds as part of defined contribution portfolios for fear of lawsuits. 

The DOL guidance was necessary after a 2015 lawsuit by former Intel employee Christopher Sulyma accused the company and its retirement plan managers of increasing risk and costs, hurting plan participants, by including private equity and hedge funds.