DC pensions: Can private equity remain ‘private’?

The private equity industry is at a crossroads as it hopes to maintain a level of secrecy while gaining exposure to millions of retail investors.

By Connor Hussey - 3 September 2020

Private equity professionals who may encourage the inclusion of defined contribution pension plans in alternative assets aren’t ready to open up to additional layers of scrutiny, experts say.

The US Department of Labor’s release of guidance greenlighting DC investment in private equity has caused some market participants to wonder if the market can retain the prized “privacy” that comes with not being publicly traded or listed on an exchange.

“While there is a desire to have a new source of funds from consumers, they’d rather do that without the transparency,” said Justin Miller, managing partner at Bain & Company.

Pantheon and Partners Group, two of the large private market participants who have actively sought guidance from the DoL on this matter in recent years, have developed private equity strategies that can accommodate DC plans. Both firms’ DC products in the US are offered as a collective investment trust – an investment vehicle similar to a US mutual fund but that is available only to qualified retirement plans such as 401(k) plans – and structured as a custom target date, target risk or balanced fund. These CITs invest in private equity and have a liquidity component to manage the participant’s deposits and withdrawals from the fund.

Allowing DC plans to invest in private funds through target date, target risk or balanced funds doesn’t translate to additional regulatory disclosure requirements. Douglas Keller, head of private wealth and defined contribution at Pantheon, believes that as the DC market evolves, it is possible Pantheon may offer other, customisable strategies to the US DC market, depending on what plan sponsors want exposure to.

That is where the disclosure picture may change.

For example, if the market were to evolve to allow DC plans to invest directly in PE, then the disclosure requirements would be heightened significantly.

“If they were to suddenly let retail investors into private funds generally, I’m sure the disclosure would be pretty much the same as a public offering, which would be onerous,” said Marie DeFalco, fund formation and structuring partner at law firm Lowenstein Sandler.

There are other ways for GPs to tap into retail money on a broad scale, which would not immediately require additional disclosures, and much of it would likely begin by offloading the complexity to banks or other related service providers.

“The most likely way for all but the very biggest firms will be to work with an intermediary, and that intermediary will handle and absorb the complexity of dealing with a retail investor or 401(k) plan,” said Miller. “But you have to pay for that.”

Administrators ‘not excited’

Plan sponsors such as Vanguard, Schwab, Fidelity and others who manage these plans could perform their own sub-accounting and internal division of shares among participants, should they offer allocations to PE, said Miller.

A disconnect exists between managers and deal professionals who could benefit from billions of dollars of new capital streams on the one hand, and the service providers and financial intermediaries that would likely have to manage much of the operational burden around reporting and document-keeping on the other.

“We have a scenario here where everyone thinks it’s a great idea, people want to do it and none of the people that actually have the technology to record-keep these plans are interested in providing that service,” Miller said.

Outsourced record-keeping service providers such as Empower, Alight or Ascensus do provide these services to a small number of clients but adding potentially millions of 401(k) users and tracking illiquid investments may require significant effort and additional investment.

“I’ve talked to one or two administrators that do record-keeping and administration, and they are not excited about having to deal with an illiquid investment at all,” said Miller. Some GPs aren’t excited about the prospect of retail investment in the industry either.

Many of the CFOs and managers speaking with sister publication Private Funds CFO in recent weeks have expressed concern about the risks the development poses, and the inevitability of heightened reporting requirements should the industry see broad allocations among plan sponsors.

“Maybe it won’t be today, but the moment you have a crash or a market dip and people’s 401(k)s get plundered because they were all heavily allocated to PE, and PE takes a hit, you can imagine what the social response would be,” said one CFO.

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