DOL opens 401(k)s to funds incorporating private equity

Will plan sponsors take the plunge?

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Will plan sponsors implement private equity in 401(k) plans, now that the Department of Labor has opened the door with its recent guidance?

Not necessarily, says Faegre Drinker partner and ERISA attorney Fred Reish. “Plan fiduciaries tend to be relatively slow to take up changes,” he told BenefitsPRO. “Most plan fiduciaries aren’t ordinarily looking for the new thing. They wait and see if others are adopting it.”

Private equity likely hasn’t been on plan sponsors’ radar of late, given the flurry of questions about complying with the SECURE Act, passed in December 2019, and then the coronavirus-prompted lockdown of the global economy in March of this year.

But 401(k) plans have been on private equity’s radar for years, as the industry has lobbied for access to the trillions of funds that are invested by defined contribution retirement plans. Although pension plans already invest in private equity funds, these plans are being phased out as fewer employers offer them and those that do are, in many cases, replacing them with defined contribution plans such as 401(k)s.

Reish, a member of the firm’s Benefits & Executive Compensation practice group,  Investment Management group, and the Financial Services ERISA Team, made it clear that he wasn’t commenting on the pros and cons of investing in private equity.

But, “the DOL said if you do it properly, you can do it. Much of the rest of the guidance is how to do it properly,” he said. Plan sponsors would overall be better “turning to ERISA attorneys and investment advisors to look at trends and possible claims,” he said. “That’s much better than saying ‘I’m not going to consider something new.’”

He said four considerations stood out for him in the DOL’s letter to Groom Law Group in which guidance was provided. The first is that plan fiduciaries have to have enough information to evaluate private equity, he said. Second is the issue of being able to provide information to participants so they can decide whether to invest. Then there’s the matter of liquidity. “Liquidity in 401(k) plans is far different from in private equity. The liquidity issue is something a portfolio provider will have to figure out,” he said.  And lastly valuation — being able to set a value on the investment, which a portfolio with private equity would have to be able to do – an action “which historically is what private equity can’t do.”

At the time of this writing, none of the big providers had said whether they would offer private equity in a fund.

For such a product to gain traction, it would likely take the form of a target-date fund and a qualified default investment alternative (QDIA), Reish said, since that is where much of the defined contribution plan money is going.

“It will take a collaborative effort between a sponsor, their ERISA attorney and their investment advisor, engaged in a prudent process, to work toward offering private equity,” he said, and with a professionally managed portfolio and an experienced investment advisor, litigation should be avoided.

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