Michael Riak once made what he considered to be a routine change to the menu of mutual funds offered to Verizon Communication employees.
“We made the call to add certain options in May of 2011,” recalls Riak, the former head of Verizon’s defined contribution plans. “When it was all said and done, the changes we made were implemented more than a year later.”
Riak’s point? Change can come slowly in the 401(k) world.
It’s a fact of life that Riak has been dealing with since he was hired in mid-2013 to help introduce Pantheon Ventures, a global private equity fund investor, to plan sponsors and consultants in hopes of persuading them to include private equity in their 401(k)s.
The firm’s marketing push really got under way late last year. Riak says he’s not the least bit surprised that Pantheon — which has nearly $29 billion under management – has yet to close a deal with its first DC client.
“This is the due diligence period for private equity in the defined contribution world,” he said. “No one familiar with the realities of plan administration could rightfully expect us to be further along than we are.”
He expects the first plan sponsor to come on board with Pantheon by mid-2015.
And he’s insistent in asserting that he’s not meeting resistance to the general concept of private equity in 401(k) plans.
“Frankly, we’ve been thrilled with the level of interest we’re finding. Sponsors, and their investment teams, want to know more about how private equity could work for their enrollees. They’ve seen the numbers, which speak for themselves. No asset class has performed better than private equity over the past five years.”
Those numbers are hard to refute. As of September 2013, PE returned more than 14 percent annually over the prior 10-year period while the S&P Index saw a return of 7.6 percent, according to the Private Equity Growth Capital Council’s website.
All told, PE has returned more than $1.4 trillion to global investors, much of it to public and private pension funds.
“We have a retirement crisis in this country,” said Riak. “Why shouldn’t private equity be utilized for the average defined contribution participant? Should it just be available to the wealthy? For years, enrollees in defined benefit plans have benefited from what is clearly the most productive asset class in recent history. Why not give the average investor in a 401(k) access?”
Riak makes a compelling case. But as confident as he is in the inevitability of private equity’s place in defined contribution plans, skeptics remain. Here are his responses to some of the more frequent questions and objections.
Private equity is too complicated for the average investor’s portfolio
Larry Zimpleman, CEO of Principal Financial Group, which provides retirement plans for 3.8 million people, literally chuckled at the proposition of PE in 401(k) plans, recently telling Bloomberg that “it’s really hard to see how that (private equity) is something that can be easily explained.”
Riak, while declining to respond to Zimpleman specifically, had this to say on the point:
“No one is suggesting private equity as a stand-alone option,” says Riak. “Private equity is complicated, but so is the balance sheet of a financial institution. So are fixed-income markets for that matter.”
Riak says the best way for 401(k)s to invest in private equity is via target-date funds. In his vision, TDF fund managers would weave Pantheon’s funds of private equity funds with other asset classes. An aggressive allocation of private equity would be about 8 percent of any given fund.
In other words, in Riak’s way of thinking, complexity is not an adequate argument against private equity. But it does put the onus on plan sponsors to know the best TDF managers and the best private-equity fund managers within that fund.
Private equity is an illiquid asset, and expensive
No problem, says Riak, “Pantheon funds come with a liquidity sleeve.”
That’s the one real difference between the private equity funds Pantheon has been providing defined benefit plans for more than a couple of decades and the ones it hopes to bring to the DC world.
Pantheon, he said, will keep a portion of the money raised in its funds in liquid assets, most likely an exchange-traded fund that is “correlative” to the value of the private-equity fund. ETFs, of course, are liquid securities that track an index, commodity or basket of assets like an index fund, but trade like a stock on an exchange.
Regarding the cost to 401(k) investors, Pantheon will not employ the traditional two-and-20 structure that’s made the most successful fund managers insanely wealthy. (Under these compensation arrangements, fund managers charge a flat 2 percent of total asset value as a management fee and an additional 20 percent of any profits earned.)
Pantheon funds will cost slightly more than the average equity funds, Riak said, but the returns it expects should easily trump the S&P 500 and easily cover the fees and expenses associated with the liquid overlays that allow investors to trade in and out of the TDFs that hold Pantheon funds.
Private equity has benefited from low interest rates that won’t stay low forever
Riak says that the question of interest rates has not come up in the discussions he’s had with plan sponsors.
But some in the private equity industry have wondered if the asset class’s strong performance hasn’t been helped, at least in part, by historically low interest rates.
Cheap financing available to private equity managers has helped margins. It’s also encouraged more private equity players into the market, and that has fueled something of a bidding war, driving up the prices of companies as more private equity competes for the acquisitions.
When rates do finally rise, fund managers will have to pay more to finance their acquisitions. That could potentially impact what they return to investors.
Riak, for one, isn’t overly concerned about the prospect of interest rate hikes.
“Private equity has performed well in all types of interest rate climates,” he said. “Ultimately, it’s the flexibility the right managers have that allows it to outperform no matter the climate. The key is in bringing the right managers and funds to 401(k) investors. And that’s where we think Pantheon is well-positioned.”
Plan sponsors will have to spend money and time educating enrollees on private equity’s place in a TDF. Will they want to?
Most 401(k) investors are unlikely to know how private equity works. The more complicated an investment, the more energy and resources plan sponsors will have to expend in explaining the option. That’s the reality of being a fiduciary.
Riak doesn’t necessarily disagree. And he says that while sponsors certainly carry the burden of educating their enrollees on investment options, much of Pantheon’s — and his — role will be facilitating that process.
“If someone wants to dig under the hood of a fund and see what’s in there, they can do so now, and they’ll be able to do so when private equity is incorporated. Yes, this is ultimately the sponsor’s responsibility.”
“Our job,” says Riak, “is to make their job as seamless as possible.”