Advocates Say DC Plans Should Be Considered ‘Accredited Investors’
Art by Mark Wang
Charlie Nelson, CEO of retirement and employee benefits for Voya, recently joined the board of directors at the Defined Contribution Alternatives Association.
Asked why he has decided to work with the nonprofit organization that provides education about the benefits of including alternative investments within a defined contribution (DC) plan framework, he tells PLANADVISER the topic has long been both a personal interest and one that Voya shares.
Simply put, Nelson says, public markets are shrinking, and an ever-greater proportion of the wealth being generated by the U.S. and global economies is locked away in private markets, which, by design, are accessible only by the wealthy.
This fact is often overlooked by individual investors and even otherwise financially savvy advisory professionals who have seen the strong growth in the value of the publically traded equity markets over the last several decades. However, as Nelson explains, the overall growth has masked the fact that there are only about half the number of publicly owned companies available to trade today than there were 20 or 30 years ago. Because the markets have grown by leaps and bounds while the number of companies being traded has halved, this, by definition, means risk is more concentrated in publically traded portfolios.
The current system governing the private equity offerings was put in place by the U.S. Securities and Exchange Commission (SEC) to help ensure less wealthy investors do not take excessive risk in complex private markets and do not invest unknowingly in highly illiquid or otherwise restrictive securities. This goal makes sense, Nelson argues, but at the same time, we must acknowledge the landscape of individual investing has changed substantially since the current system was put in place, thanks in no small part to the dramatic growth of the defined contribution (DC) plan system.
Nelson says the DC Alternatives Association is, for all these reasons, making the case to the SEC and other regulators, such as the Department of Labor, that it is time to update the definition of “accredited investors,” i.e., those who are eligible to participate in private offerings and to invest in certain other types of “alternatives.” He notes that Voya recently joined the DC Alternatives Association in submitting a comment letter to the SEC, making this same argument. The letter encourages the SEC to, among other things, consider modifying the definition of accredited investor to make private offerings more readily available to retirement plan participants, who benefit from fiduciary oversight under the Employee Retirement Income Security Act (ERISA) or a similar state or federal fiduciary standard.
The Opportunity Set
J.P. Morgan Asset Management’s newly updated long-term capital markets assumptions provide some context for these comments. The projections suggest that developed market equities may grow by 6.3% in U.S. dollar terms annually over the next decade. The projection for large-cap U.S. equities is somewhat lower, at 5.60%, while the emerging market economies are projected to grow around 9.2% in the aggregate—albeit with much higher volatility potential.
The projections for private equity investments are much higher than those for developed market equities, with more palatable volatility profiles compared with the emerging markets. On a cap-weighted basis, J.P. Morgan projects private equity will generate 8.8% growth per year over the 10 to 15 year forecast horizon.
Standing Up for Main Street
“I’m very excited to join a number of my industry peers in an effort to try to advance the cause of creating additional investment opportunities for DC plan investors in the United States,” Nelson says. “I think this is an important issue, and we think it’s a great cause to join—to work with industry providers, regulators and Congress to address this gap that DC plans investors are subject to.”
Nelson says it is important for DC plan advisers to learn more about this topic and to take steps to better educate their clients about the opportunities available today and the need for changing some of the SEC rules. He says another important factor at play here is the increasing average age of companies that are taking the step of going through an initial public offering (IPO).
“Think of some of the companies that have gone through recent IPOs,” Nelson says. “The average age of the companies doing an IPO today is much older than even what we saw just 10 years ago. This means the companies coming onto the public exchanges are already more mature and it means there is a lot of wealth that has already been reaped by private investors, before public investors can get involved.”
Nelson says success in this endeavor would not mean that DC plans invest solely in the private markets—far from it. He says an appropriate allocation to alternatives and private equity assets for the typical DC plan participant might be just 5% to 10%. .
“There’s an increasing volume of wealth generation opportunities that fall under the broad umbrella of alternatives,” Nelson says. “Not all of them are venture capital-type, high-risk opportunities. For all these reasons, I think there is momentum at the SEC for them to start looking at this issue. In the meantime, we want to make sure plan sponsors and plan advisers know this is an important conversation to push forward.”