After the passage of the SECURE1 Act of 2021, which allowed unrelated employers offering a 401(k) plan to join a Pooled Employer Plan (PEP), the growth of PEPs has been significant. SECURE 2.0, which enabled 403(b) plans to also join them, further accelerated the trend. The benefits of the structure are significant, including decreased fiduciary exposure and administrative work, as well as lower costs—especially for plans with more than 100 participants that have to conduct an annual audit. The advent of PEPs coincides with a key regulatory shift regarding private markets.
Safe Harbor for Private Markets Exposure
Specifically, the President’s Executive Order directing the Department of Labor to establish rules to allow defined contribution plans to include private market investments like private credit, private equity and real estate (the proposed rules were released in April) has increased activity by alternative asset managers in targeting retirement plans.
“The newly proposed DOL rule establishes a safe harbor framework with six factors that provide fiduciaries with a way to evaluate investment options, including private market investments and document their process,” notes Michelle Rappa, Client Advisor-Retirement at Neuberger. Rappa believes the expected rule could lead to increased adoption of private assets since the rule provides fiduciaries with “objective, thoughtful and analytical process to rely on for investment selection.”
In our view, the case for private investments, especially private equity, is attractive: More companies now wait to go public or avoid doing so altogether, leaving retail investors and many DC plans unable to participate in a key economic segment. Institutional investors, including larger defined benefit plans, have long invested in private markets. According to the Georgetown Center for Retirement Initiatives, those that don’t invest in the asset class have not benefited from a potential estimated additional 15 basis points in annual returns.2
PEPs Could Help Lead the Way
Here’s where PEPs come in. While the DC industry (especially advisors and record keepers) is having robust discussions about whether and in what way private markets assets should belong in retirement plans, many plan sponsors (especially smaller ones) remain wary. Not only do some not understand the asset class, but they also may worry about potential fiduciary liability under ERISA.
Naturally, retail investors struggle with the liquidity, transparency and cost issues presented by private markets investments. And while DC plans are institutional by definition, smaller ones may act more like retail investors and rely on retail advisors to help select and monitor investments. Even if these private markets investments are imbedded within professionally managed products such as target date funds and managed accounts, the lack of understanding and concern about liability that have led many plans to prefer low-cost index funds could continue to mute adoption of more expensive, less transparent and more illiquid private markets investments.
PEPs are overseen by a pooled plan provider (PPP), which acts as the plan sponsor with which individual employers are affiliated. The professionals with these entities may have a more sophisticated understanding of private markets than a small individual plan.
“PPPs as fiduciaries of the PEPs can also rely on the framework in the newly proposed DOL rule, so we may see increased adoption by PEPs when the rule is final,” says Rappa. “PEPs are an efficient way for small plans to access private market investment strategies that they might not be able to as a small standalone plan.”
That said, adoption of a new type of investment can be slow within highly regulated markets like ERISA plans, which carry extra layers of liability. Target date funds, for example, only grew after the 2006 Pension Protection Act gave DC plans safe harbor to include balanced funds as the default investment when using automatic enrollment.
“One of the biggest challenges for both wealth advisors and DC plans and retirement plan advisors, when it comes to smaller plans, is how to manage them administratively and efficiently while still having time to focus on their key clients.” says Rappa. “PEPs can help advisors by moving some of the fiduciary responsibility to the PPP and shifting the advisor role to selecting and monitoring of the PEP. Then the advisors can focus on working directly on participant engagement with the plan.”
The bottom line? We think that a combination of the DOL rule and increased use of PEPs has the potential to broaden adoption of private markets solutions, allowing greater exposure for participants to an important, but, until recently, underutilized segment of the investment universe.
