Beyond the relative lack of transparency, the costs and risks attached to private equity will continue to be sponsors’ and advisors’ downfall, he said.
Private equity funds usually charge plans a flat fee and then get a percentage of the profit. “Typically, the private equity fund will charge a flat fee of say $50,000 [depending on the size of the plan] and charge another 20% profit tied to performance,” Watkins said.
The fees can be hard to justify given the fact that actively managed funds, on average, do not beat passively managed investments such as ETFs and mutual funds.
Ripe Commissions
“As Vanguard’s John Bogle said, ‘You get what you don’t pay for,’” Watkins said. “Many of the advisors to plans also charge 7%—a very nice commission for selling these private equities.
“Unfortunately, in a lawsuit, there is a good chance plan participants will lose, the sponsors will lose, but the broker will still get his or her 7%. It’s one of the higher commissions.”
Even registered investment advisors who don’t accept a commission can be sued, the attorney said. “I’d ask advisors the same question: What info did you have, who provided it. Inevitably, it always comes back that the private equity fund provided the information.”
Public pension funds that manage employees’ retirement savings have a long history of investing in private equity. But 401(k) plans have stayed away because of the complex regulations and their concerns about being sued.
The Department of Labor’s ruling was praised by Jay Clayton, chairman of the Securities and Exchange Commission, which is considering ways to let retail investors access asset classes that have been largely reserved for the wealthy.
Under current SEC regulations, firms such as Apollo Global Management Inc., Blackstone Group Inc., Carlyle Group Inc. and KKR & Co. are mostly limited to raising money from high-net-worth investors and sovereign wealth funds and pension funds. But that, too, could change soon if the SEC lifts qualified plan prohibitions.