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DOL Issues Common-Sense Information Letter About Private Equity in DC Plans

In an information letter released in June, the Department of Labor said that defined contribution (DC) plan sponsors considering the inclusion of private equity in their plans (in a multi-asset framework) must adhere to the same standards and weigh the same considerations as they would for other asset classes. Namely, plan fiduciaries “have duties to prudently select and monitor any designated investment alternative under the plan.”

Background

The DOL’s June 3 letter came in response to a request from the Groom Law Group (on behalf of Pantheon Ventures (US) and Partners Group (USA)).

(Estimated reading time: 2 min 27 sec)

The DOL wrote that “a plan fiduciary would not violate the fiduciary’s duties under section 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 letter reminds plan sponsors that the inclusion of private equity must stem from a prudent selection and monitoring process. The fiduciary must engage in an objective, thorough, and analytical process that considers all relevant facts.

Specific to private equity, the DOL said, fiduciaries should also consider:

  • Liquidity and valuation: The sizing of the positions should take into consideration the cost and liquidity of the asset class. With regard to valuation, the letter mentions that plans may require independent valuation according to Financial Accounting Standards Board Accounting Standards Codification 820, “Fair Value Measurements and Disclosures.”
  • Diversification: The sponsor should consider the diversification of risks over a multi-year period.
  • Capacity and ability: Those in a fiduciary position should have the capabilities, experience, and stability to manage an asset allocation fund that includes private equity investments effectively given the nature, size, and complexity of the asset class.

For participant-directed plans, the fiduciary must also determine whether plan participants will be provided adequate information regarding the characteristics and risks of the investment alternative to enable them to make an informed assessment regarding an investment in the fund.

Bottom Line

While not a ringing endorsement, the letter does provide clarity around appropriate steps and considerations for private equity in DC plans. As sponsors consider including private equity—or any asset class for that matter—the potential benefit to participants must be weighed against the additional complexity and cost.

Over the past decade, straying from “mainstream” asset classes (public equity and fixed income) brought little benefit to offset the expense as low-cost beta (think the S&P 500 Index and the Bloomberg Barclays US Aggregate Bond Index) boasted solid returns. Also consider that the 37% of plans using passive target date options often have fees well below 10 basis points. Quite simply, there has not been a benefit to being exotic when it comes to asset class selection.

For private equity or any other asset class to gain a foothold, we will need the next decade to provide a tangible benefit to diversification to justify the cost and complexity of implementation.