In late 2014, Partners Group plunged into the defined-contribution-pension market by announcing the first product to offer traditional private equity exposure within a target-date fund. But it took until the end of last year for the Baar-Zug, Switzerland–based private equity firm to win its first commitment, a $50 million allocation from a private pension fund in the U.S. Midwest.
Partners expects to launch similar products in the U.K. and Australia during the first quarter of this year, once regulators approve them. “We’re playing the long game,” says Robert Collins, a managing director at the $47 billion firm’s New York office who oversees its U.S. defined contribution business. “This is the future of pension funds, and we want to be there.”
After enjoying success with traditional defined benefit pensions, private equity firms face growing pains as they seek to cater to the defined contribution market. Alternative investments such as hedge funds and real assets have folded easily into these newer plans, bolstered by a boomlet in liquid alternative products. But for private equity, it’s been harder to make the shift.
Still, Partners and its peers see big opportunities in the rapidly growing defined contribution market. Between 2000 and the third quarter of last year, U.S. defined contribution assets more than doubled, climbing from $3 trillion to $6.5 trillion, according to Washington-based trade association the Investment Company Institute. Assets in IRA plans almost tripled during the same period, from $2.6 trillion to roughly $7.3 trillion. By contrast, private defined benefit pensions grew modestly, from $2 trillion to $2.8 trillion. Government defined benefit plans saw their assets rise from $3 trillion to $5 trillion.
The private equity industry grew up around defined-benefit-pension systems because allocators to those plans had the ten- to 20-year horizon needed for such investments to mature. But in the new defined contribution world, individual investors and plan sponsors want products that offer the ability to get in and out on a whim, without the hefty fees common to the industry — a tall order for traditional general partners.
Partners Group developed its product by making only minor alterations to its existing strategy. “We were already running an evergreen fund structure with monthly valuations,” managing director Collins recalls. “So we built on our knowledge there to move to a daily valuation structure without sacrificing certain types of investments.”
The firm’s defined contribution fund relies on an integrated strategy that combines allocations to traditional private equity investments, secondaries, listed private equity, listed infrastructure and cash. Unlike in a typical private equity fund, this mix offers daily liquidity, making it more suitable for defined contribution plans. “The vast majority of the portfolio is the real thing in terms of traditional private equity exposure,” Collins notes.
General partners like Carlyle Group, KKR & Co. and limited partners like Pantheon Ventures are looking at vehicles that target another side of the defined contribution marketplace: registered investment advisers. Last October, London-based Pantheon and AMG Funds announced the ’33 Act registration of the AMG Pantheon Fund, a retail private equity vehicle with a 0.7 percent management fee. AMG Funds is the U.S. retail arm of Affiliated Managers Group, a $619 billion global asset manager; Pantheon Ventures (US) is majority owned by AMG. By allocating directly to the multimanager fund, investors can gain access to a variety of general partners across vintage years, strategies and geographies.
“There is a lot of excitement around new fund structures for the defined contribution market,” says Susan Long McAndrews, a San Francisco–based partner at $32 billion Pantheon. It’s been difficult for plan sponsors and advisers who have experience investing in private equity to find opportunities for retail investors, McAndrews notes: “I think you’re going to see a lot of different options come to market as people figure out what works for them, either through new business lines or custom solutions.”
Even with all of the interest from plan sponsors in new products, it will be an uphill battle for firms to educate retail investors about what private equity means in a portfolio. “There is a learning curve when it comes to adding alternatives to defined contribution plans,” says Jeri Savage, a partner in defined contribution research at Rocaton Investment Advisors in Norwalk, Connecticut. “Often individual investors don’t know the difference between a stock and a bond, so there is a big educational gap there,” adds Savage, whose firm has about $425 billion in assets under advisement.
This gap is already leading to litigation spurred by the perceived risk of alternatives, as well as by the private equity industry’s high fees. Last October a former employee of Intel Corp. brought a lawsuit against the U.S. technology giant’s plan sponsor for including investments in hedge funds and private equity as part of its defined-contribution-plan portfolio. In his complaint, Christopher Sulyma claims that Intel’s plan sponsors violated their fiduciary duty by allocating to alternatives, which he says are too risky and expensive.
That case and two others have investment consultants and plan sponsors holding off on recommending what a new private equity product should look like. “A lot of people are waiting to see how lawsuits like the one brought in October shake out,” says Ross Bremen, partner and defined contribution strategist at NEPC, a Boston-based pension investment consulting firm whose defined contribution group has $147 billion in assets under advisement.
These cases argue that prudent investments should behave like mutual funds and offer quick returns, Bremen observes. However, that’s not the return profile that private equity is designed to provide. “I think it’s a mistake for people to conflate fiduciary prudence with high return in a short time,” Bremen warns. “Prudence and high returns aren’t directly correlated.”
Bremen believes it may take a culture shift for investors in defined contribution plans to consider private equity and other products with long-term return profiles. Integrated strategies such as those bundled in the Partners Group and Pantheon Ventures funds allow for the daily liquidity that mutual fund investors are used to, but the upside for such offerings increases over time as the traditional private equity investments they contain pay off.
Rocaton’s Savage stresses that all of these products are essentially first drafts. According to Pantheon’s McAndrews, the answer for defined contribution plans may lie in experimenting with different risk-return options. “I think it’s still going to take some time to see what that looks like in terms of product types,” she says. “We think the most likely home is through customization within target date funds.”