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STRATA’s Patrick Hagen Featured in PlanAdviser’s “Many Project Mild Interest in Private Equity Among DC Plans”

STRATA Trust Company Featured on PlanAdvisor

Article originally published in PlanAdviser by Lee Barney – 

On June 3, the Department of Labor (DOL) issued an Information Letter published in response to an inquiry by Groom Law Group on behalf of two of its private equity clients.

The letter states that defined contribution (DC) plans can invest in private equity if that asset class is limited to 15% of the assets in a target-date fund (TDF), target-risk fund or balanced fund.

Retirement industry insiders, for the most part, welcome this move by the DOL, but many point to the challenges of including private equity investments on a DC platform. Most notably, they point to plan sponsors’ and participants’ reluctance about high fees, the complexity of valuing an investment vehicle that contains private equity, the long-term investment horizon of private equity investments and the fact that they are illiquid and cannot provide daily valuations.

The DOL tries to address these questions in its Information Letter by asking retirement plan fiduciaries to run through a series of considerations before including private equity in their investment lineup. Does the inclusion permit participants to still adequately diversify their holdings? How will the private equity manager inform participants of its investment choices and performance? Can the plan create an infrastructure to limit its exposure to private equity to 15% of its assets? Will private equity funds permit participants to take distributions or exchanges when they are needed?

At this early juncture, it remains to be seen whether plan sponsors will feel they can get satisfactory answers to these crucial questions. In fact, sources who are already active in the private equity market are skeptical that they’ll be able to work with DC plans, even though they applaud the DOL’s Information Letter.

Mark Biegel, a wealth advisory partner with BDO, says he would like to see the “democratization of private equity,” particularly as he serves high-net-worth investors and family offices. This marketplace is perhaps more likely than DC plans to embrace broader access to private equity, given the lesser prevalence of fiduciary concerns.

Keith Lamoutte, chief investment officer (CIO) at RSM U.S. Wealth Management, says plan sponsors would certainly have to consider the cost of offering private equity.

“Historically, private equity is one of the most expensive asset classes,” Lamoutte says. In addition to this, the plan sponsor and its investment committee would need to incur extra costs for the operational oversight of an investment containing private equity.

“This runs counter to the trend in the DC space to lower costs,” he says, pointing out that mutual funds have created lower-cost share classes just for 401(k) plans and that many sponsors have moved their investment lineup to index funds in order to offer their participants the lowest-cost funds possible.

Before a plan can offer an investment with a private equity component, the sponsor has to take into account everyone’s risk tolerance within the plan, says Patrick Hagen, national director at STRATA Trust. “Private equity investments are not for everybody.”

“As a fiduciary, you have a fairly high burden to demonstrate that the benefits of offering private equity outweigh the challenges,” Lamoutte says. “We won’t see a big roll-out of this, in my opinion.”

In spite of these challenges, David O’Meara, director of investments at Willis Towers Watson, says he thinks the move is “a strong positive” for defined contribution plans and their participants.

“We are proponents of diversification and inclusion of alternatives in portfolios,” he says. “In 2018, we issued a white paper on alternatives in DC plans with Georgetown that showed that alternatives can boost retirement income by 17% while also reducing downside risk.”

Biegel says private equity has the potential to deliver outsized returns, based in part on the illiquidity premium.

“In the past 25 years, private equity has surpassed the Barclays Index by 300 basis points [bps],” Biegel says. “In the past 20 years, it has surpassed the index by 500 basis points, and in the past 15 years, by 400 basis points. Generally speaking, I am excited because it gives plan sponsors a way to diminish volatility and to increase performance.”

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