Private markets in my Pension – yes please
The idea of investing in pensions is that the money stays invested over time. I have argued that when DC schemes start paying pensions they do so on a collective basis. If you do that, you do not have to disinvest to pay off pensioners who want out and get their money back.
Reading today’s FT , I understand that one of the big private market fund managers has been arguing that American DC funds (401K) should be given access to private funds.
Partners Group had argued that giving 401k holders access to private equity investments would “materially improve retirement security for millions of working families”, given that private markets played an “increasingly vital role in the US economy”.
I agree with this argument.
I hear excitement from other US managers, the door is open as last Friday the American rule makers ordered that they could
But 401K are not collective pensions, they are like UK retail DC funds where every saver is on their own.
The result is that a new type of fund is needed, step forward the “Evergreen fund”, a fund ideally suited to selling to DC plans – starting with 401K to start, with DC accumulation and Decumulation funds likewise encouraged to get stuck in. The Evergreen fund is all things to everyone.
Let’s take a look round..
Evergreen – no thank you
The practice of offloading assets that cannot find a buyer on funds with dry powder is a clever trick for private markets fund managers. They can pay off original investors with the money raised while leave the evergreen fund holders with valuations for the assets that no one else would pay. In the old day this would have been a bid/offer spread with a wide margin what the investors pay and what they can realise their assets at.
Evergreen funds are open not closed so look just right for DC pensions where savers are needing to get their cash back. The evergreen fund not only picks up the dirty stuff from existing private market funds but can be used to pay out cash to savers who want their money back at short notice.
Indeed an Evergreen fund can do anything you want it to , so long as you don’t mind if it doesn’t deliver harder stuff like returns.
Value for Money from flexibility?
Well I think that giving people flexibility on their funds in retirement restricts the returns that private market investments can make and this will reduce the pensions that can be paid.
I see “Evergreen” as about right for DC pensions but second rate for pensioners. What you need to get the best income from your pot is for the fund that backs your pension to be (a) collective and (b) invested without intention of selling the investments unless it is done so for investment reasons. Including evergreen funds in a DC investment strategy will compromise the pension and the reason for including them is to ensure that money can be taken to pay cash.
Liquidity is nice to have when drawing down from your DC pension but it comes at a price. Watch this video to get the pitch and ask yourself if you want to pay for Evergreen liquidity!
Consider illiquidity carries a premium in terms of return, if you want to get the full return, do not buy Evergreen funds. Go collective and don’t expect capital from your pension.
Value for money is usually considered “returns v cost”. But it’s more than charges that will cost you pension, it’s often your need for flexibility in drawdown.
In the states, we have two kinds of investments in 401k plans. First are the CORE investments – where the plan investment fiduciary has a duty to identify the appropriateness of the investment for ANY and EVERY plan participant, and where the fund is sufficiently liquid to permit no less frequent than quarterly transfers/withdrawals/loans. Those funds must have “reasonable” fees. There is a mandated quarterly disclosure of fees.
The second type of investment would generally be provided through a directed brokerage account. Here, you might have limits on those investments – including limiting use to qualified investors (as provided under SEC regulations), with multiple disclaimers, perhaps limiting the percentage of plan assets that can be invested, and perhaps requiring a “bullet” form of investment, where the participant acknowledges that the private equity investment must be held to term (typically 4 to 7 years).
Simply, no plan investment fiduciary is likely to add private equity as a CORE option, and, I doubt they would allow workers to elect a private equity investment through directed brokerage.
What we are hearing is that the PE folks want to add their stuff so that there is an allocation within Target Date Funds – where 90+% of the Qualified Default Investment Alternatives are TDFs which are almost always opaque. That would be maximum penetration, quickly.
Here is why:
(1) American workers have had a median tenure of less than five years for the past seven decades. That is, most don’t remain with an employer for the typical up to 7 year term of a private equity investment.
(2) A substantial majority of 401k plans now use automatic enrollment features, typically enrolling individuals at hire, where the median account balance for those defaulted into a target date fund (typically the Qualified Default Investment Alternative) would be less than $30,000 during the first five years. So, if PE was added to TDFs, the majority of investors would have no idea they have an allocation to PE.
(3) Almost every 401k plan has daily valuation these days, so, the CORE investments must be valued daily, and a TDF with PE would likely have to allocate a larger percentage of assets to capital preservation investments.
(4) Intel had TDFs with an allocation to PE. They just finished six years of litigation over that decision. In America, if you are a plan sponsor, if you litigate YOU LOSE (no matter the outcome).
Thanks Benefit Jack – this is as good if not better than the blog!
If several dated closed end finds are purchased with the aim of providing cash for 5 years then giving the benefit of 20-30 year compounding. As a back stop to getting the timing wrong or dealing with shocks a secondary market is needed. In SSAS world this can be arranged between younger and older members.