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DOL Opens 401(k)s to Private Equity, but Not Hedge Funds

Anchin AlertJuly 29, 2020

DOL Opens 401(k)s to Private Equity, but Not Hedge Funds

In a June information letter, the U.S. Department of Labor (DOL) made it possible for 401(k) participants to invest in private equity funds. While there are restrictions and 401(k)s do not have the same access as defined benefit plans, this change opens new options for investors. We look at the impact of this ruling along with what it could mean for other alternative asset classes like hedge funds.

401(k) Restrictions

Prior to the new DOL guidance, sponsors of 401(k) plans and other defined contribution plans could not allow private equity or hedge funds as investment options as these types of funds would not meet the fiduciary responsibilities standards under ERISA. This meant that people could only invest money in these funds directly if they met the accredited investor standards which require that they have a net worth of over $1 million or earned more than $200,000 per year, or $300,000 if married filing jointly.

Historically, private equity has averaged an annual long-run return 4% to 5% higher than the annual return of the S&P 500, according to a J.P. Morgan Asset Management report, and yet only a small percentage of Americans could benefit.

The DOL Information Letter

In the letter, the DOL modified the rules to make private equity funds more accessible. Investors still cannot invest their 401(k) savings directly in such funds, but they can now invest in broader funds (like mutual, target date, asset allocation or funds of funds) that have a private equity component. The private equity investment must be part of a larger, diversified fund that is more liquid.

The reasoning behind this approach is that retail investors are more likely to need their cash short-term than institutional investors, so the private equity structure with liquidity restrictions could be problematic. By using this compromise position, investors could gain access to private equity investments without being locked in.

Adoption

It’s still up to the 401(k) plan administrators to decide whether they will offer these private equity-based funds to their participants, and plan sponsors usually take time before including a new asset in their offerings. Large brokerage firms will also need to decide whether they will add private equity as part of their menu of funds available to retirement plans. 

Given that the total 401(k) market is roughly $5.6 trillion, if even a small percentage of investors move into this investment class, it will still provide a large new source of capital to the private equity sector.

Hedge Fund Status

The DOL only modified rules for private equity funds. Restrictions still apply for hedge funds. It is still possible that they will reconsider the rules for hedge funds and other alternative assets in the future. Whether they will do so remains unclear, but the fact that hedge funds were not included in this ruling should not be seen as the DOL making a final decision on their future status as 401(k) plan investments.

This summer, investors have gained access to yet another option to help them reach their financial goals. We will keep you updated as the investment and retirement landscape continue to evolve.

As always, please contact your Anchin Relationship Partner or Jeffrey Rosenthal at 212-840-3456 with any questions that you may have.

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