FORTUNE — Last year I wrote that private equity firms eventually would find a way to let non-millionaires into their funds, as traditional capital sources like public employee pensions and corporate defined benefit plans continued to fade. It seems to be happening faster than I imagined.
Fortune has learned that at least one veteran private equity adviser is working on a new product that would be offered to participants in defined contribution plans. Even if those participants fall below the accredited investor thresholds that currently prevent them from direct investments in private equity funds.
The adviser spoke on the condition of his identity, and the identity of his firm, not yet being disclosed (sounds to me like the lawyers haven’t completely vetted all this yet). Here’s how it would work:
Defined contribution plans like 401(k)s usually include something called “target-date funds,” often as a default for workers who don’t specify where they want their contributions to go. Traditionally these go into mutual funds tied to a participant’s age. Basically, it would be higher-risk/higher-reward for younger participants, and become more conservative as the fund glides toward the “target date” (i.e., retirement).
There also are custom target-date funds where plan sponsors use a mix of both mutual funds and separate accounts with institutional money managers in other asset classes (real estate investment trusts, commodities, hedge funds, physical real estate, etc.). This is where private equity could come in, as one of those other asset classes. Likely via fund-of-funds managers that can provide a diversified “sleeve” of exposure.
Such a strategy bypasses the accredited investor rules, since it would be the plan sponsor (not the individual) making the commitment. Kind of like how public school teachers indirectly invest in private equity through their pension systems.
Target-date funds also should be able to handle the fact that private equity funds don’t allow for investor redemption. First, such vehicles maintain around 20% liquidity. Second, they should have three or six-month redemption “gates” that give the funds time to maneuver in a crisis (e.g., find secondary market buyers, even if at a discount).
The trickiest part of applying this structure to private equity is what to do with participant commitments on Day 1. Participants would need instantaneous exposure to the asset class, but there is no such thing as a core private equity fund where money can be parked while looking for more exact opportunities. It doesn’t sound like the advisor has a surefire answer to this yet, but it likely would come via either secondary transactions or temporary replicator strategies. Or both.
Such vehicles also would require daily pricing, rather than the quarterlies that private equity funds provide their limited partners. That means the target-date fund manager would need to update valuations on a daily basis for cash-flows, market events, etc. This would require the development of some new analytic software, but it seems manageable.
Again, this isn’t coming tomorrow. But the advisor we spoke with has been working with some plan sponsors, and it doesn’t sound too far off…
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