The private equity train is rolling down the tracks toward your clients’ 401(k) plans. Recent litigation failed to stand in the way, Empower has given it a strong nudge, and the full weight of the White House is about to be behind it. As the movement picks up steam and all three branches of government are thinking about private equity, advisors are likely to face more questions and, in time, demand.
The Judicial Branch Weighs In
The Ninth Circuit Court of Appeals recently refused an opportunity to construct a roadblock that might hinder the momentum toward greater access to private equity within 401(k) plans. In Anderson v. Intel, the court considered participants’ arguments that the Intel fiduciaries had breached their duties of prudence and loyalty by using hedge funds and private equity funds in custom portfolios, including both target date funds and global diversified funds. Intel had redesigned those custom funds in response to the 2008 market crash and ensuing recession, with the intention to decrease correlation with public markets and the risk of large losses during a market downturn.
The court upheld the district court’s dismissal of the participants’ claims. In doing so, it provided some useful guidance that will undoubtedly support others’ intentions to use private equity in 401(k) plans:
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Intel clearly disclosed the aims of its funds. Participant disclosures emphasized the objectivesof decreasing correlation to public equity markets, providing greater downside protection in faltering markets, and acknowledged the likelihood of underperformance in rallying markets.
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Equity-heavy retail funds are not a meaningful benchmark for the Intel custom funds. Intel’s custom benchmarks—with the same asset allocation as the custom funds—were more appropriate than plaintiffs’ comparisons to benchmarks with different aims, risks and potential rewards.
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Private equity funds are not per se imprudent. The plaintiffs argued that private equity funds are inherently so risky as to always be imprudent. The court disagreed, noting that—particularly when used within a portfolio—the “prudence of each investment is not assessed in isolation but, rather, as the investment relates to the portfolio as a whole.
Lessons From the Legislative Branch
Shortly after the Intel decision, Empower captured U.S. Sen. Elizabeth Warren’s (D-Mass.) attention with its announcement that it intended to offer private market investments to retirement plans. Warren, in her role as the ranking member of the Committee on Banking, Housing and Urban Affairs responded with a letter to Empower’s CEO in which she articulated several concerns about private investments, such as “weak investor protections, its lack of transparency, expensive management fees and unsubstantiated claims of high returns.” She also requested that Empower respond to a series of questions regarding its plans for protecting investors.
Empower doubled down on its intentions in a response asserting that the vast majority of retirement savers have been excluded from private markets because access has been historically limited to institutional investors and the wealthy. Although its response did not directly address the series of questions Warren had posed (which prompted her to follow up to reiterate those questions), Empower did indeed confirm that its approach will be one of “Innovation with Guardrails,” requiring plan fiduciary approval, holding investment managers to ERISA standards, and controlling risk through design.
Executive Order Forthcoming
In the coming days, President Donald Trump is expected to issue an executive order that will lend further support to those seeking to include private investments in defined contribution plans. The details of that order are the subject of great speculation, but it appears quite certain that it will demonstrate the president’s unequivocal support for—if not his insistence on—retirement plan fiduciaries using private equity investments. It is also quite likely that the order will instruct the Department of Labor, and perhaps the Securities and Exchange Commission, to issue subsequent guidance intended to allay fiduciaries’ concerns.
Helping Advisors to Prepare
Many questions persist. What will the executive order say? How long will it be before we receive meaningful guidance from one or more federal agencies? What will that guidance say? Does private equity really serve participants’ best interests? Is private equity just another high-cost solution in search of a problem?
Whatever the answers may be, the Intel case reminds us that traditional fiduciary principles persist. Some advisors will opt not to board the private equity train. But for those who do, the ride will be safer—for clients, participants, advisors, and advisors’ firms—if plan fiduciaries subject to the private equity investments to a prudent process that acknowledges potential risks, articulates related goals, and provides for an ongoing system of monitoring.
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