Oh, the irony. Just as market headlines reveal huge worries about \u201cprivate credit\u201d and \u201cprivate equity,\u201d the\u00a0Labor Department\u00a0(which is responsible for the security of pensions and retirement accounts) has proposed new guidelines to allow those very same instruments to be\u00a0included\u00a0in the 401(k) plans of unsophisticated individuals. They say it is aimed at \u201cdemocratizing access\u201d to these assets.<\/p>\n
The irony is inescapable. The fox is guarding the henhouse! And\u00a0you\u00a0are one of the chickens who will be slaughtered if your company retirement plan decides to offer these risky investments. History shows not only that they underperform over the long run, but also that at the very moment you might need your retirement dollars, these investments are unlikely to be liquid.<\/p>\n
When the idea was first floated to include private investments in retirement plans, I wrote a column immediately \u2014 \u201cPrivate Equity Targets Your 401(k),\u201d published last July \u2014 and called it a terrible idea. The opening paragraphs bear repeating:<\/p>\n
\u201cWall Street has a new target. With nearly $9 trillion in assets, 401(k) plans have caught the eye of\u00a0Wall Street\u00a0insiders. For years, they have been investing in \u2018private equity\u2019 and venture capital deals. They find small, promising companies and lend their capital and management expertise \u2014 hoping to sell out in the public stock markets for huge gains.<\/p>\n
\u201cBut in recent years, there has been little opportunity for these insiders to cash in and realize profits to be distributed back to their investors. A slowing market for initial public offerings (IPOs) means many are \u2018stuck\u2019 in their deals, with little liquidity.<\/p>\n
\u201cStock market volatility, higher interest rates, and a preference for large tech companies have muted deal activity, and the chance to redeploy profits (and fees) into new deals. Those who need to sell out of these deals must take a huge discount because there are so few buyers.<\/p>\n
\u201cOrdinary investors aren\u2019t aware of this dire situation for\u00a0Wall Street\u00a0tycoons, since individuals have been largely prohibited from investing in private equity, unless they can demonstrate they have significant risk capital and financial assets outside the value of their home.<\/p>\n
\u201cThat\u2019s all about to change.\u00a0Now Wall Street\u00a0is looking to let ordinary investor get in on these deals \u2014 by including them as investment options inside their 401(k) plans. And they\u2019re getting help from the current administration.\u201d<\/p>\n
Stating the obvious<\/p>\n
In the past nine months, those words have rung true. The \u201chidden\u201d problem of illiquidity has risen to the surface as the so-called smart money tries to get out of their own private equity and debt deals. Many of those high-yielding loans were made to software companies, now under pressure from AI. Suddenly, the returns don\u2019t look so secure. And neither do the investments, raising great concern on\u00a0Wall Street.<\/p>\n
Here\u2019s one headline from the\u00a0Center for Economic and Policy Research: \u201cPrivate Equity Investors Are Taking Losses to Cash Out of Investments in Aging Companies.\u201d The\u00a0report notes<\/a>: \u201cLast year, global private equity fundraising across private equity strategies fell 12.7 percent to $480.29 billion, according to data from\u00a0S&P Global Market Intelligence. This was the third consecutive year that global fundraising declined.\u201d<\/p>\n Yep, they are running out of suckers, so they\u2019re turning to the unsuspecting money in the nation\u2019s retirement plans. They\u2019ve already hit up many pension plans, run by sophisticated investment managers who are supposed to understand risk. But individuals make the decisions in 401(k) and 403(b) plans. So why not dangle the enticing prospect of higher returns to these novice investors?<\/p>\n History says beware<\/p>\n The idea that private equity could generate outsize returns started with the huge\u00a0Yale University\u00a0endowment fund in the 1980s, pioneered by\u00a0then-manager\u00a0David Swensen. That strategy emphasized heavy diversification into illiquid alternative assets \u2014 such as private equity, venture capital and real estate \u2014 over traditional stocks and bonds.<\/p>\n Well, it turns out that a simple investment in the S&P 500 stock index has given a far better return \u2014 with lower risk and more liquidity. That is borne out by the real-life strategy of the\u00a0University of California\u00a0endowment, run by\u00a0Jagdeep Singh Bachher, who seven years ago shifted a significant portion of the fund\u2019s assets from hedge funds, private equity and venture capital into low cost stock index funds.<\/p>\n