By way of general background, the PE Letter is not the first time the Department has addressed alternative investments. In a 1996 Information Letter, the Department discussed the fiduciary considerations applicable to the utilization of derivatives as part of a pension plan’s asset management strategy.3 Not surprisingly, there are similarities in the Department’s application of ERISA’s fiduciary principles. The Department’s PE Letter, however, shares the Department’s current views on alternative investments and applies those views in the context of a participant-directed individual account plan.
In addressing PE investments in the PE Letter, the Department limited its consideration to private equity investments that would be offered as part of a multi–asset class vehicle structured as a custom target date, target risk or balanced fund, with respect to which each fund would have a sufficient pool of assets to diversify the exposure of plan participants to PE investments with other investments with different risk and return characteristics and investment horizons. Also, the funds would need to be designed to provide sufficient liquidity to allow participants to change investments or take benefit distributions.
As with the Department’s 1996 Information Letter, the PE Letter lays out guideposts for plan fiduciaries as they determine if and how to include PE investments as part of their retirement plan investment platform. In evaluating whether to include an allocation of PE as a designated investment alternative to a particular investment vehicle, the responsible plan fiduciary must evaluate the risks and benefits associated with the investment alternative. The factors to be considered include the following:
- Whether the plan fiduciaries overseeing the fund have the necessary skills to evaluate and monitor PE investments, or whether they should rely on an outside consultant or delegate investment selection responsibility to an investment manager.
- The long-term impact of the PE allocation in the fund in terms of diversification and expected return net of fees, including management and performance fees.
- The percentage of the fund to be allocated to PE. In a footnote, the PE Letter references a U.S. Securities and Exchange Commission regulation that establishes a 15% limitation on investment in illiquid assets for registered open-end investment companies. Although not necessarily controlling for purposes of DC plans, this footnote does provide some indication of the Department’s general thinking on this issue.
- Whether the investment option will include features regarding liquidity and valuation that allow participants to take benefit distributions and exchanges into other plan investment options within the plan. The potential limitation on PE investments mentioned above could serve to provide the necessary liquidity through the other investments in the fund; or, alternatively, the PE portion of the fund could be structured in such a manner to provide that needed liquidity directly.
- Whether the long-term nature of the PE investments and any potential liquidity restrictions align with the plan participant population in terms of how participant age, employee turnover, and contribution and withdrawal patterns may affect the ability of participants to take distributions or change investment options with the frequency they would desire.
- The adequacy of disclosures to be provided to participants regarding the character and risks of the plan investment option that includes PE, so as to allow participants to make informed decisions as to whether to invest in the fund.