The Wall Street Journal reported on Tuesday that Trump is expected to sign an executive order in the coming days allowing 401(k) plans to invest their assets in private equity.

It’s a proposal that’s raising red flags among some investment experts, who say a 401(k) should typically be a simple and relatively low-risk investment vehicle. Private equity investments, meanwhile, are often concentrated in a small number of portfolio companies, illiquid, and carry valuations that can be difficult to measure day-to-day. They’re also much less liquid than stocks and bonds.

Trump’s green light doesn’t come as a surprise to those monitoring the private equity space, but it’s concerning nonetheless.

“Private equity kind of always gets what it wants in Congress, but I think it’s a bad idea,” Jeffrey Hooke, professor at the Johns Hopkins Carey Business School, said. “It’s illiquid, the fees are very high. Private equity funds, for the most part, don’t beat the stock market.”

“I don’t think it’s a good investment for the rank and file retail market,” Hooke added.

An inevitable development

The push to include private equity in retirement plans is just the latest development in a long-running trend of combining public and private markets.

The private equity industry experienced explosive growth during the pandemic as firms bought up portfolio companies with cheap debt. But now, as higher rates stymie private equity dealmaking, firms are eyeing a liquidity opportunity: gaining access to the $12 trillion 401(k) market.

Brian Payne, chief private markets and alternatives strategist at BCA Research, described this development as “an exit ramp for the current situation going on for private equity.”

Traditional exit opportunities — such as selling to a public company, another private equity firm, or going public — have dried up.

According to a PwC analysis, between 4,000 to 6,500 private equity exits have been delayed in the last two years, and the firm believes funds will soon be forced to sell off their portfolio companies as limited partners demand capital distributions.

As a result, private equity firms have been lobbying the Trump administration for access to retirement vehicles. It won’t just be private equity looking for retail exposure — Hooke expects other alternatives like private credit and real estate to follow suit.

Increased risk

Private equity tends to generates higher returns than the market as a result of the illiquid nature of the asset class, as investments can be locked up for a decade or longer. Retail investors require more liquidity, which will eat into private equity returns over the long term, according to Payne.

Private equity investments also come with steep management fees that could decrease returns.

“It’ll make the retirement plans suboptimal,” Hooke said. “When people retire 20 to 30 years after investing in private equity, returns are going to be a little less than one would expect.”

While retirement vehicles typically have longer timelines, reducing the need for immediate liquidity, Payne sees a risk if an economic downturn increases unemployment and forces more people to tap into their 401(k)s.

Moody’s Investors Service recently raised a similar concern, noting that retail investor participation in the private markets poses systemic risks.

Source: Businessinsider