On June 3, the U.S. Department of Labor (DOL) issued an Information Letter (Letter)¹ concerning private equity investments within an asset allocation fund that is a designated investment alternative in an individual account plan, such as a 401(k) plan. The Letter provides guidance for including private equity investments within an asset allocation fund offered under an individual account plan without violating requirements of the Employee Retirement Income Security Act of 1974, as amended (ERISA). As stated by Labor Secretary Eugene Scalia, “This Information Letter will help Americans saving for retirement gain access to alternative investments that often provide strong returns.”

The Letter was issued in response to a request on behalf of two private equity funds regarding the use of private equity investments as part of a professionally managed multiasset class vehicle structured as a target date fund or balanced fund. Importantly, the Letter states that the target date or balanced fund would (1) limit its private equity investments, (2) provide a diversified portfolio with sufficient liquidity by investing the remainder of its assets in securities with readily ascertainable market values, such as publicly traded securities, and (3) prohibit plan participants from investing in private equity vehicles directly on a standalone basis.

Considerations for Plan Sponsors

The ERISA duties of individual account plan fiduciaries include prudently selecting and monitoring investment options available to plan participants that provide for the diversification of risk over a multiyear period with an appropriate range of expected returns net of fees.

The Letter outlines a number of considerations that plan sponsors should undertake in discharging their ERISA duties with respect to investment alternatives with a private equity component, such as:

• whether adding the particular investment alternative would provide participants with a more diversified set of investment options

• whether the investment alternative is overseen by plan fiduciaries or managed by investment professionals

• whether the investment alternative has addressed the unique features of private equity investments with regard to its inclusion in a participant-directed individual account plan, such as cost structures, complexity, disclosure obligations and liquidity

• the plan’s features and participant profile (e.g., participant ages, normal retirement age, anticipated employee turnover, and contribution and withdrawal patterns)

• whether the plan fiduciary has the skills, knowledge and experience to make the required determinations or whether the plan fiduciary needs to seek assistance from a qualified investment professional

• whether the investment alternative continues to be prudent and in the best interests of plan participants on a periodic basis

• whether plan participants will be furnished adequate information regarding the character and risks of the investment alternative to enable them to make an informed assessment regarding making or continuing an investment in the fund.

Takeaways for Plan Sponsors

A plan sponsor would not violate its ERISA fiduciary duties solely by offering participants a professionally managed investment alternative with a private equity component. However, in including such an alternative, plan sponsors must consider anticipated opportunities for investment diversification and enhanced investment returns, as well as the complex investment strategies, complex valuation, reduced regulatory disclosure (in comparison to publicly traded securities), and higher fees associated private equity investments.

Takeaways for Asset Managers

With DOL’s approval, we expect that many asset managers will be interested in pursuing designated investment alternatives with a private equity component as another channel of distribution.

While some large, diversified asset managers may possess the skill and personnel to manage both the private equity portion and the liquid asset portion of an investment alternative with a private equity component, we expect that most asset managers will seek out complementary public or private asset managers with which to offer products jointly. For instance, private equity managers may act as a subadviser to a target date fund structured as a mutual fund or collective investment trust. These investment vehicles must be carefully designed to meet participant needs (including with respect to liquidity) and to comply with the federal securities laws and ERISA.

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