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DOL Affirms Private Equity in Asset Allocation Funds

Target date funds and other asset allocation solutions for defined contribution plans continue to grow and evolve. The DOL issued Information Letter 2020-06-03 on June 3, 2020 that clarified the use of private equity investments in target date funds, balanced accounts and asset allocation solutions for ERISA defined contribution plans.

Generally, target date funds or asset allocation funds are offered in defined contribution plans as the plan’s default option or QDIA. The QDIA tends to be a major portion of most defined contribution plan assets.

The new DOL guidance allows plan sponsors to select asset allocation funds that include private equity investments in the underlying investments of the glide path. The guidance, however, does affirm the use of private equity investments as a stand-alone fund in define contribution plans.

This new guidance provides greater flexibility to plan sponsors when evaluating the underlying investments of asset allocation funds. Plan fiduciaries are still responsible to conduct a due diligence review in the prudent selection and monitoring of QDIA investments.

Private equity investments have long been used in defined benefit pension plan, endowment, and foundation portfolios. This is newsworthy because this is the first time that the DOL has considered the use of private equity in asset allocation solutions for defined contribution plans.

The DOL guidance identified several factors that plan fiduciaries should consider when selecting an asset allocation fund that includes private equity:

  • Fiduciaries should have sufficient expertise to evaluate asset allocation funds that include an allocation to private equity. Fiduciaries may need to retain a third-party investment consultant to evaluate these investments.

  • Understanding the fee structure of asset allocation funds with private equity for reasonableness is also a fiduciary responsibility. Private equity may have performance fees or higher investment management fees than traditional investments. Performance, net of fees, should be considered.

  • The impact on diversification and the expected overall risk/return benefits are important considerations.

  • Private equity investments are considerably less liquid than public equities. The asset allocation funds should be able to provide sufficient liquidity and pricing transparency for participants to transfer in and out of the fund, as needed.

  • The fiduciaries should evaluate the participant disclosures to understand if the disclosures adequately describe the levels of potential risks, any liquidity constraints, and specific investment characteristics that enable participants to make informed decisions about the asset allocation funds.

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