UPDATE 1: Offering PE For 401(k)s, Pantheon Crosses New Frontier

  • Target-date funds may allocate to PE
  • Pantheon touts benefits of diversification
  • Investors won’t have direct PE option

Until now, target-date retirement funds—designed as set-it-and-forget-it mutual funds that become more conservatively invested as people approach retirement age—have usually consisted of a mixture of stocks and bonds. But beginning this summer, London-based Pantheon, a fund-of- funds manager, plans to offer a private equity option to sponsors of target-date funds available through 401(k)s. If these sponsors sign up, investors could begin to gain access to private equity by the beginning of 2014, Pantheon said.

Pantheon’s offering begins to address one of the fundamental imbalances of the investing world: While beneficiaries of pension funds gain from professional managers who have access to alternative investments, people who rely on defined contribution schemes—401(k)s and individual retirement accounts (IRAs)—typically do not. They miss out on the potential rewards (and hazards) of private equity, venture capital an any number of other asset classes that investment professionals could use to balance a portfolio and diversify risks. 

As a component of target-date funds, Pantheon’s offering will be a modified fund of funds that will likely be called the Pantheon Global Select Portfolio. Spearheading the offering will be Michael Riak, newly hired from Verizon to be head of U.S. defined contribution.

The opportunity for such offerings—both for investors and firms offering such vehicles—could be huge. Assets held by 401(k)s and IRAs accounted for $9.4 trillion in 2011, according to the Investment Company Institute. That’s far larger than the $2.8 trillion in assets held by the 100 largest U.S. public pension plans at the end of 2013, according to the U.S. Census Bureau.  

Pantheon, which manages more than $24 billion in private equity assets, sees managing money in target-date funds as a major potential growth area. Kevin Albert, global head of business development, said his firm’s products offer “vintage year diversification, industry diversification, geographic diversification and manager diversification.” Its offering to target-date fund sponsors will also be diversified among venture capital, private debt, buyouts, growth equity, secondaries and co-investments.

Kelly DePonte, a partner at Probitas Partners, a placement agency, said that Pantheon’s effort “makes more sense than anything else I’ve heard lately” regarding retail access to private equity.

A new vehicle from The Carlyle Group, the CPG Carlyle Private Equity Fund LLC—which was announced in March—has an unusually low minimum commitment of $50,000, but it is still limited to accredited investors. The vehicle, launched through the Central Park Group, is essentially a fund of funds diversified over Carlyle’s private equity platform. And like most funds of funds, this fund adds an extra layer of fees on top of the Carlyle Group’s own carry and management fees. The fund also has unusual features: it draws down all committed capital immediately and offers investors the ability to cash out after just two years.

Like Pantheon, Carlyle Group has been at the forefront of positioning the firm to take advantage of the retail market. In December, David Rubenstein, Carlyle Group’s co-head, said that individual investors were “where I see the biggest increase in private equity investments.” He also predicted that there would soon be a relaxation of the rules currently restricting most investors from investing in private equity. “Non-accredited investors will be coming into private equity … through their 401(k) programs because eventually there will be pressure on the SEC in Washington.”

But any expansion of target-date funds into alternative assets won’t mean that 401(k) investors will be able to choose an individual fund from, say, Kohlberg Kravis Roberts & Co. “Pantheon won’t be a stand-alone private equity option,” said Albert. “It will be part of an asset allocation within a target-date fund,” he said. At the end of the day, allocation decisions will be made by the target-date plan’s sponsor, and decisions on which individual private equity funds to invest in will be made by the fund-of-funds firm, in this case Pantheon.

Pantheon’s offering also won’t have its own carry fee. Albert said the management fees for such a fund would be “south of 1 percent,” with the actual fee determined by the amount of money contributed by each target-date fund sponsor. Meanwhile, the expected returns for the private equity investments would be 300 to 500 gross basis points over public market indexes.

While target-date fund sponsors may decide to dip their toes into the new Pantheon fund, Albert figures that initial allocations will be between 2 and 3 percent for funds nearing their target dates, and up to 10 percent for funds 30 and 40 years from their target dates.

Yet before these products can be sold to target-date fund sponsors, Riak identified two hurdles that will need to be overcome: valuation and liquidity. Since target-date funds have a daily close, a daily valuation (and a method for calculating that) will need to be worked out. Second, because people change jobs and 401(k)s are portable, there needs to be a process for closing out investments in funds with private equity assets in them. To do that, these funds need to have sufficient liquidity.  

Albert predicts that other fund-of-funds firms and private equity sponsors will provide similar options for the “retail” market, so he expects more competition in the space. “After a couple of years, success will ultimately depend on performance,” he said.

Tapping into the money currently held in 401(k) plans “has the potential of adding several billion dollars” to private equity, said Albert. “It will start slow, but it’ll just snowball.”