The U.S. Department of Labor (DOL) issued an Information Letter under the Employee Retirement Income Security Act (ERISA) concerning private equity investments as a component of a professionally managed asset allocation fund offered as an investment option for participants in defined contribution (DC) plans.

In the letter, Louis J. Campagna, chief of the Division of Fiduciary Interpretations in the DOL’s Office of Regulations and Interpretations, says “a plan fiduciary would not, in the view of the department, violate the fiduciary’s duties under Sections 403 and 404 of ERISA solely because the fiduciary offers a professionally managed asset allocation fund with a private equity component as a designated investment alternative for an ERISA covered individual account plan in the manner described in this letter.” The DOL points out in a news release that the letter refers to a professionally managed multi-asset class vehicle structured as a target-date, target-risk or balanced fund. The Information Letter, however, does not authorize making private equity investments available for direct investment on a standalone basis. 

Jon W. Breyfogle, an attorney with Groom Law Group, who asked for the DOL’s view on behalf of Pantheon Ventures (US) L.P. and Partners Group (USA) Inc., tells PLANSPONSOR, “Private equity is a common investment for DB [defined benefit] plans and endowments. There has been a lot of litigation in the DC space that has chilled innovation. This guidance provides a roadmap for plan fiduciaries to prudently offer private equity in a DC plan as part of a target-date fund [TDF] or other diversified managed investment option. We did not ask DOL to address standalone private equity options in DC plans, as such they were not addressed in the letter.”

For years, DB plans have unwound their exposures to public equities, and diverted some of their risk investments into alternative assets such as private equity, real estate and hedge funds, among others. These can offer not only diversification away from volatile equities, but also risk-adjusted returns that are superior to public market counterparts. Results of a study published last year by Neuberger Berman research partner the Defined Contribution Alternatives Association (DCALTA), in collaboration with the Institute for Private Capital (IPC), suggest that including private equity funds in DC plan portfolios both improves performance and has diversification benefits that lower overall portfolio risk.

Serge Boccassini, head of institutional global product and strategy at Northern Trust Asset Servicing in Chicago, previously told PLANADVISER that plan sponsors in the U.S. may have concerns about including private investments in DC plan fund menus. As a fiduciary, plan sponsors worry whether they are making an appropriate decision to include investments that are not necessarily understood. There is concern about the cost of alternative assets and how that plays into participants’ savings accumulation, and there are concerns about the illiquid nature of some private investments.

In addition, the case Sulyma v. Intel Corporation Investment Policy Committee may have discouraged plan sponsors from including alternative investments in plan options. While the case is well-known for reaching the U.S. Supreme Court and the high court’s interpretation of “actual knowledge” in ERISA cases, when it was initially filed, Christopher M. Sulyma claimed that the defendants breached their fiduciary duties by investing a significant portion of two DC plans’ assets in risky and high-cost hedge fund and private equity investments through custom-built target-date funds.

Campagna addresses these concerns in the letter, noting that “there are important differences between a fiduciary’s decision to include private equity investments in the portfolio of a professionally managed defined benefit plan, and the decision to include an asset allocation fund with a private equity component as part of the investment lineup for a participant-directed individual account plan.” He mentioned the complex organizational structure, potentially higher fees, illiquidity and complexity of valuations, among other things.

“The letter was sought so that plan sponsors know what the relevant considerations are when considering offering private equity as part of a target-date or other managed fund, which might serve as a QDIA [qualified default investment alternative],” Breyfogle says. The letter includes five paragraphs detailing considerations for plan fiduciaries in evaluating and monitoring investments that include private equity. “The letter addresses how plan sponsors can meet their fiduciary obligations if they wish to offer exposure to private equity as part of a larger investment strategy. As the information letter notes, there is a lot of evidence that private equity can offer benefits of improved diversification and investment returns,” Breyfogle adds.

Groom’s summary of the guidance is here.

Both Pantheon and Partners Group issued press releases following the DOL’s announcement about the Information Letter welcoming the agency’s view.

“The illiquid structure of traditional, closed-end private equity vehicles renders them incompatible with the U.S. DC pension system, which prefers all underlying fund allocations to provide daily liquidity and pricing and highly standardized purchase and redemption procedures,” Partners Group notes. It says it introduced a private equity offering structured specifically to meet these requirements in 2015. Pantheon says it introduced a product in 2013 with daily pricing and liquidity that is intended to be used in target-date, target-risk or balanced funds. The firms say they have advocated for greater parity between the investment options available to DB and DC pension plans.

“The Information Letter is a critical step toward improving retirement outcomes at a time when research estimates 50% of households are ‘at risk’ of not having enough income to maintain their living standards in retirement,” says Susan Long McAndrews, partner and member of Pantheon’s Partnership Board. “We believe private equity has an important role to play in enhancing potential retirement outcomes and today’s announcement provides necessary clarity to plan sponsors that private equity can be incorporated as an allocation option under ERISA.”

“The Department of Labor has taken a major step toward modernizing defined contribution plans and providing participants with a more secure retirement. At a time when working families are struggling to save, this guidance gives fiduciaries the certainty they need to finally provide main street Americans access to the same types of high-performing, diversifying investments as wealthy and large institutional investors, all within the safety of their 401(k) plans,” says Robert Collins, managing director, head of Partners Group’s New York office.

“This Information Letter will help Americans saving for retirement gain access to alternative investments that often provide strong returns,” U.S. Secretary of Labor Eugene Scalia says. “The letter helps level the playing field for ordinary investors and is another step by the department to ensure that ordinary people investing for retirement have the opportunities they need for a secure retirement.”

Chairman of the U.S. Securities and Exchange Commission (SEC) Jay Clayton commends the department’s efforts to improve investor choice and investor protection, saying the Information Letter, “will provide our long-term main street investors with a choice of professionally managed funds that more closely match the diversified public and private market asset allocation strategies pursued by many well-managed pension funds as well as the benefit of selection and monitoring by ERISA fiduciaries.”