Private-equity titans and their well-heeled lobbyists have finally succeeded in gaining access to 401(k) money, the primary retirement savings plan for private-sector workers. The Labor Department issued an "information letter" that tells plan sponsors it's OK to include private equity under limited circumstances.
Until now, private-equity funds have been limited to well-to-do investors and institutional investors such as pension funds. The new guidance doesn't allow direct investments in private equity. The investment must be bundled into something like a target date fund. Nevertheless, the shift marks a dramatic change in policy. The Trump Administration justified the move as a step toward democratizing investing.
The move "will help Americans saving for retirement gain access to alternative investments that often provide strong returns," said U.S. Secretary of Labor Eugene Scalia.
I can see why private-equity "masters of the universe" want access to the huge sums socked away in the 401(k) market. My hope is that plan sponsors won't let private equity into their target date funds and similar 401(k) options.
Private-equity performance is too opaque, and private-equity fees too onerous and too complicated for the 401(k) saver. Warren Buffett — the Oracle of Omaha — criticized private equity at Berkshire Hathaway's annual meeting last year. "We have seen a number of proposals from private-equity funds where the returns are really not calculated in a manner that I would regard as honest," he said. "If I were running a pension fund, I would be very careful about what was being offered to me."
The same "be very careful" caution applies to 401(k) plans. In "How Do Private Equity Investments Perform Compared to Public Equity?" three economists found in a review of 800 funds that private-equity returns did exceed the S&P 500 benchmark before 2006 by 3% to 4% annually, on average. Performance since then has roughly equaled the S&P 500. The 11th annual Global Private Equity Report by Bain & Co. calculated that 2019 "marked the first time ever that 10-year returns in the public markets matched those for private equity."
Of course, private-equity performance on average could do better going forward. If people with substantial net worth want to invest with private equity, fine. The retirement savings of the 401(k) employee is another matter. Complex investment vehicles like private equity will push up overall fees, a drag on 401(k) returns. Complex financial products come with difficult to fathom risks. Low-fee broad-based equity index funds are far superior options in constructing target date portfolios.
Chris Farrell is senior economics contributor, "Marketplace," and Minnesota Public Radio.
