Coming Soon: Private Equity In 401K Plans

Private equity firms are making moves to tap individual investors through defined contribution plans. Several have strategies in the works to offer private equity products through 401(k) platforms in 2015.

Individual investors are a new type of investor for private equity firms, which typically cater to institutions and high-net-worth investors. Private equity investments are not publicly traded or listed. Private equity firms use money raised through institutional investors and the wealthy to buy companies, revamp them to boost returns and sell them at a profit down the line, typically four to seven years later.

Pension funds are among the institutional investors and have long invested in private equity to boost returns. Private equity has outperformed more than any other asset class managed by pension funds in the last 10 years producing 12.3% annually, according to the Private Equity Growth Capital Council.

Defined benefit or traditional pension funds have been on the decline for decades as companies have transitioned to defined contribution plans. Private equity firms are courting the $4.3 trillion 401(k) plan market at a time when there is no end to growth in sight. (For related reading, see: How to Invest in Private Equity.)

Private Equity Players

Global private equity firm Pantheon Ventures, which has $32.2 billion in assets under management, is among the first to pursue 401(k) platforms. It plans to offer exposure to private equity via target-date funds.

Target-date funds are a popular investment choice for retirement among investors. They invest in a mix of asset classes and rebalance portfolios based on a specific target date for retirement. A target-date fund becomes more conservative as it approaches and passes the target-date transitioning from growth investments, such as equities, to income-generating investments, such as fixed income. They are typically offered in 5-10 year intervals so that investors can choose a fund close to the year in which they would like to retire. (For more, see: The Pros and Cons of Target-Date Funds.)

Pantheon is initially courting plan sponsors with $100 million in assets. (For related reading, see: Why You Should Be Wary of Target-Date Funds.)

Switzerland-based Partners Group is also developing a private equity investment product designed for 401(k) plans that is expected to launch in 2015. It plans to offer private equity via a collective investment trust (CIT), which has been filed with the Securities and Exchange Commission. CITs are commingled or pooled investment vehicles that combine a variety of assets. They have been offered in 401(k)s for decades.

More than 50% of Partners' CIT offering will be allocated to Partners Group Private Equity LLC, which has approximately $1 billion in assets, in addition to private equity funds from heavyweights such as KKR & Co. L.P. (KKR). It will also invest in listed private equity securities. (For related reading, see: Guidance on Pairing Annuities, Target Date Funds.)

The Carlyle Group (CG) is also reportedly among the private equity firms examining the 401(k) market.

Liquidity Challenges

Providing private equity as an investment option in 401(k) platforms presents challenges when it comes to liquidity and pricing assets. The underlying assets of private equity funds are generally illiquid and difficult to value, unlike mutual funds, exchange-traded funds, stocks and bonds. Defined contribution plans, meanwhile, provide liquidity and prices daily on investment options available to plan participants. (For related reading, see: 6 Problems with 401(k) Plans.)

By offering private equity exposure via target-date funds and a collective investment trust. Pantheon Ventures and Partners Group will be able to provide liquidity and prices daily.

Beyond Plain-Vanilla

Mutual funds, stock and bonds are the dominant investments in defined contribution platforms.

Proponents of private equity as an option in 401(k) platforms maintain that the average investor will now have access to the potentially higher returns that this type of alternative investment yields compared to the current offerings from which they have to choose. (For more, see: Private Equity for Retail Investors.)

“Meanwhile, more than 50 million Americans rely on 401(k) plans for their retirement that typically are self-managed and restricted to a combination of traditional assets of stocks, bonds and cash,” Scott Higbee, a partner at Partners Group said in an opinion piece published in the Wall Street Journal. “These defined contribution plans generally don't provide investors with the opportunity to add a range of alternative assets to the mix. Given the current dismal yields on mainstream fixed-income securities, they should,” he added.

The Bottom Line

Expect to see private equity products make their way onto the shelves of 401(k) platforms in 2015. While only a few private equity firms are prepping products so far others are closely evaluating doing the same, some of which are likely to follow suit. (For more, see: Private Equity for the Public.)