What access to the $6.2tn retirement savings market means for private equity

But private equity firms may still have a long road ahead of them to get their investments on Americans’ 401(k) menus.

What did the Labor Department change?

Less than it seems. The letter is important not because it changes the rules, but because it gives comfort to companies and other retirement plan sponsors that have worried they could be sued if they made private equity investments available to their retirement-plan participants.

 “The funny thing is nothing actually changed legally,” said Josh Lichtenstein, a partner at Ropes & Gray who advises on issues related to retirement plan investments and asset management.

It was always legal to offer a private equity component in a 401(k) plan. The Labor Department’s letter was sent at the request of two private equity firms, Partners Group and Pantheon Ventures, that already offer funds designed for 401(k) plans.

However, most retirement fund sponsors haven’t signed up for such offerings out of concern they could be sued for violating their duty to retirement plan participants. There has been a spate of suits related to construction of 401(k) plans and fees in recent years.

“What this really does more than anything is [it] helps to level set what the rules have always been,” Lichtenstein said.

Why did the Labor Department do this now?

Partners and Pantheon first asked the department for clarity on the issue about two years ago, and overall, private equity firms have been trying for over a decade to unlock the 401(k) market. But a few factors came together to prompt the government to make this move now.

The Securities and Exchange Commission, which collaborated with the Labor Department on the letter, has made it a priority in recent years to open private markets investments to ordinary Americans. The rise over the past decade of target-date funds —  which blend various types of assets, shifting from riskier to more conservative as the investor ages — means there is now a convenient, widely used vehicle for getting private equity into 401(k)s. The Labor Department said private equity could be included in diversified retirement funds, but not as a standalone investment.

The Labor Department also cited an executive order last month from president Donald Trump asking government agencies to “remove barriers” to economic growth to help the recovery from the coronavirus pandemic. The department oversees private sector retirement savings plans under the Employee Retirement Income Security Act of 1974.

How can firms prepare products for the 401(k) market?

Private equity fund of funds managers have the inside track, since they have experience building diverse portfolios, said Lichtenstein. The most direct path is to develop relationships with companies that sponsor target date funds, or trying to develop a standalone product that they can market to the sponsors of target date funds, he said.

Rob Lee, an analyst at investment bank Keefe, Bruyette & Woods. who covers publicly traded private equity firms, thinks it will likely be easier for them to get onto retirement fund investment menus through partnerships with companies that already have a 401(k) distribution infrastructure, rather than building it from scratch.

One example of a relationship between a fund sponsor and a private equity firm is Vanguard Group’s partnership with HarbourVest Partners, announced in February.

When will retirement savers have the option of investing in private equity?

It could be years. It will take time for more firms to develop 401(k)-ready offerings, and Lichtenstein thinks the first workers likely to have access to it will be those who work for large employers that already offer custom target date funds to plan participants.

Susan Long McAndrews, a partner at Pantheon, says the disruption around the pandemic has made it hard to forecast when private equity might see more use in 401(k) plans. Lee of Keefe, Bruyette & Woods doesn’t expect products tailored for 401(k) plans to have any significant effect on investment capital raised by the firms he covers over the next three years.

Isn’t this move controversial, with all the criticism of private equity right now?

Less than you might expect, at least so far. The response has been muted from politicians who have in the past have taken a stand against private equity, such as Senators Elizabeth Warren (Democrat, Massuchusetts.), Bernie Sanders (Independent, Vermont.) and Representative Alexandria Ocasio-Cortez (Democrat, New York).

 The timing of the announcement — in the middle of a pandemic and protests against police conduct — may have contributed to the quiet response.

Mark Iwry, who oversaw national retirement policy as a senior US Treasury Department official during the Clinton and Obama administrations, said he agreed with the guidance in the letter, but criticised the Labor Department’s justification for issuing it.

“Unfortunately, Labor’s press release makes clear that the accompanying guidance was issued in quick response to the May 19 presidential executive order directing agencies to ‘remove barriers’ to our economy’s post-coronavirus recovery,” he said by email. “But prudent retirement investing — regardless of whether private equity plays any role — is certainly not a barrier to national economic recovery.”

Eileen Applebaum, a researcher at the Center for Economic and Policy Research who has testified before Congress on private equity, said in an email that the clarification “should be seen as a gift to private equity firms, not a favour to workers who are unlikely to cash in on mythical high PE returns.”

Source: penews