Some of America’s leading financial firms are hoping to sell the White House on what sounds like a compelling idea: Open employer-sponsored retirement plans to the private investments they manage, so regular folks can reap returns currently reserved for the wealthy.
Unfortunately, the idea has some serious flaws. If the new administration doesn’t see them, employers and investors should.
Private capital has captured the commanding heights of finance with a persuasive pitch: Investors who don’t need their money back anytime soon should earn a premium by putting it into illiquid investments with longer horizons, rather than paying extra for easy-to-sell assets such as publicly traded stocks and bonds.
As of mid-2024, North American private capital funds, focused on everything from midsized businesses to infrastructure, managed more than $8.3 trillion, largely from institutions such as insurers, pension plans and university endowments. That’s up from about $2.6 trillion a decade earlier.
Now these funds are aiming for a new frontier: the more than $12 trillion sitting in employer-sponsored retirement plans such as 401(k)s. At first glance, it’s a good fit. Today’s workers mostly won’t need the money for decades. Why should they funnel so much of it into stocks, helping drive valuations of the largest US companies to historically extreme levels? Why should only so-called accredited individual investors, who are already relatively wealthy, have access to the expanding and potentially lucrative sphere of private assets?
Technically, plan sponsors can already include private assets. But doing so is legally fraught: They can get sued for breaching their fiduciary duty to participants. To overcome this, the administration would have to instruct the Labor Department — or ask Congress — to create some kind of safe harbor.
There are at least three reasonable objections to that idea.
One is transparency. Investors in public securities always know what they’re worth: They can see market prices based on actual trading and extensive disclosures. Private assets, by contrast, often leave them in the dark, relying on “fair value” estimates from fund managers. Even big institutional investors complain that they lack the information needed to properly understand the funds’ performance and risks.
Costs are another concern. Investing in illiquid stuff is expensive. Private funds often charge 2% of assets plus 20% of gains, compared to less than 0.1% of assets for a typical 401(k) offering. Meanwhile, evidence is mixed on whether end investors, after fees, do much better than they would in public markets, particularly when adjusted for risk. Research suggests that less sophisticated investors get the worst returns — a dynamic that doesn’t bode well for the 401(k) crowd.
Timing, finally, also presents a risk. Many private capital managers have lately struggled to deliver the returns investors expect, as illiquid assets have proved, well, hard to sell. To generate cash, they’ve turned to practices including myriad types of borrowing and so-called continuation funds, which raise money from new investors to pay off old. This could be a hiccup or an impending reckoning. In any case, there’s a danger that if retail investors pile in, they’ll be left holding the bag.
Could such concerns be addressed? To some extent, maybe — if private capital could improve pricing and disclosure, or if it were limited to a small part of big target-date funds, whose managers might be better equipped to assess the risks. Still, the industry would have to convincingly demonstrate a performance or diversification benefit beyond the stock and bond funds already in 401(k)s. Barring that, it’s hard to see why private assets belong in the tax-advantaged accounts intended to ensure a comfortable old age for millions of Americans.
One hopes the White House will recognize this. If not, it’ll be up to the employers who sponsor such plans — or to their workers. They’ll need to choose wisely.
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