Information Letter 06-03-2020

The U.S. Department of Labor (DOL) issued an information letter to Groom Law Group on behalf of its clients, Pantheon Ventures, L.P. and Partners Group (USA), Inc., who have developed private equity investment vehicles designed to be used as a component of a managed asset allocation fund (such as a target date fund or balanced fund) in a participant-directed individual account plan, i.e. 401(k), 403(b) plans. Note that the letter does not authorize making private-equity investments available for direct investment by plan participants. The DOL information letter gives examples of how a plan fiduciary might develop a multi-tiered prudent process for evaluating a fund that included private equity including, but not limited to, whether the fund aligns with the plan’s features and participant profile (i.e. ages, normal retirement age, anticipated turnover, contribution and withdrawal patterns, etc.). Additionally, to satisfy fiduciary obligations under ERISA section 404(c), fiduciaries must determine if participants will be furnished adequate information to make an informed decision about investing in the fund. If the plan sponsor considers this type of fund as a potential Qualified Default Investment Alternative, it must evaluate whether the fund meets all QDIA standards including, for example, the ability for participants to trade daily without financial penalty.

What You Should Know

  • Media headlines stating the DOL has given a “green light” to private equity are a bit misleading. The DOL has not given carte blanche approval for plan fiduciaries to include private equity investments in defined contribution plans.
  • Information Letter states that, in the DOL's view, a plan fiduciary would not violate its duties under ERISA solely because the fiduciary offers a professionally managed asset allocation fund with a private equity component as an investment option. The letter reiterates that plan fiduciaries must prudently select and monitor any investment option offered to participants.
  • Plan fiduciaries must develop and apply a prudent process taking into account unique aspects of private equity vs. publically-traded equity.
  • Private equity can add diversification and additional returns over publically traded securities, but due to its higher risk, liquidity constraints, and high fee structure has historically been viewed as “off limits” for participant-directed plans. If product providers can find a way to overcome these barriers, we may see plan fiduciaries show interest in becoming further educated about these types of investments.
  • Private equity in a Limited Partnership (LP) structure is complex, has limited liquidity (lock up periods 7-10 years), requires independently determined valuations of the portfolio companies, and has minimal investment gains (and frequently investment losses) in the early years of a vintage. Other than any newly created vehicles for participant-directed plans, there are some publically-traded companies such as KKR and Carlyle Group that invest in private equity. Managed allocation funds may decide to incorporate publically-traded stocks like these as solutions to the liquidity constraints of LP private equity.
  • Asset allocation funds will have to consider whether and how to incorporate private equity vehicles. It will take time for investment product providers to evaluate the feasibility of private equity vehicles that claim to be designed as a component of a managed asset allocation fund.