Workers do not require private equity in 401(k) plans – Retirement Research Center
Private equity is liquid, high fees, and does not generate high returns for state/local plans
The president has just issued an executive order to encourage the increase in private equity and private credit and other alternative investments as options for the 401(k) program.
The mission of the Department of Labor (DOL) is to achieve this. Some believe that expansion may be limited to 10% to 20% of target date funds, the default investment option in most 401(k) plans, but the target may be broader.
My point is: Why bother? As far as I know, the only party that drives private equity in the 401(k) plan is the private equity industry. Furthermore, private equity has many negative effects and our study of the performance of national and local pension plans shows that increasing private equity does not increase returns or reduce volatility in these plans.
To date, DOL has sent two letters to warn the trustees, but has not prevented anyone from introducing private equity into 401(k)s. The first was June 2020, to apply to solicit Dol's opinions on behalf of Pantheon Ventures and Partners Group. After uncritically repeating all applicants’ arguments about private equity, the institution does point out that private equity investments tend to be more complex, longer, longer levels, less liquidity and higher fees than traditional investments. However, it concluded that the trustee will not violate ERISA's duties simply by providing the asset fund with a portion of the private equity.
A year later, fearing that the previous government letter could be considered widely recognized by private equity in the 401(k) program, the institution issued a clarification statement. In a previous letter, the letter highlighted the caution of trust skills, knowledge and experience required to select and monitor private equity options. It also reiterated that DOL has not yet endorsed or recommended that private equity be included and trustees should be wary of marketing efforts, otherwise meeting. Why change the location now?
My view is that people should invest in what they understand, and private equity is not a transparent investment. Additionally, it takes years to achieve the return, and participants who leave early do not have to pay higher fees. Private equity simply increases the unnecessary risk of savings retirement.
Furthermore, it is clear that private equity produces future returns in retirement plans. Although one study concluded that increasing private equity holdings in 401(k)s would boost returns in a small amount, the analysis ended in 2020 until the stock market rose. The results of our 2022 study show that having more private equity will not increase returns on state and local pension plans during the 2001-2022 period. Yes, private equity has helped before the financial crisis, but since then, it has not had a statistically significant impact (see Figure 1). Given that this exercise may not fully take into account the fees of private equity and the stock market has soared since 2022, private equity may even damage overall portfolio earnings compared to traditional equity.
Furthermore, in terms of diversification, private equity has no statistically significant impact on volatility. Yes, private equity people get rich, but it is not clear that participants in retirement plans benefit. Why should the trustee take such a big risk?
One potentially convincing argument for introducing at least a small amount of private equity in the 401(k) program is that companies increasingly finance activities through private capital rather than public capital, so plan participants can only access a portion of the market activity. The figures obtained in private equity and credit are not easy, but the best estimates available suggest that in 2023, private equity accounts for 10% of the stock market and private credit is about 7% of the private debt market (see Figure 2). My take on these numbers is that plan participants can access stock and credit markets in the form of familiar publicly traded stocks and bonds. It's nice to talk to them when private equity and credit make up 30-40% of the total. Before this, in my book, the risks associated with private equity far outweigh any potential gains.
