President Trump’s executive order to allow private equity investments in 401(k) plans opens up new opportunities for both retirement investors and asset managers.
However, experts are split on whether this change is a win for retirement nest eggs or others who stand to benefit more.
The private equity industry — which has seen deal flows stagnate and a mature institutional market with limited room for growth — is celebrating the possibility of expanding into new, lucrative territory.
But these investments can be riskier than the stock and bond portfolios most workers currently hold in their 401(k)s.
Here’s what you should know about the inclusion of private equity investments in 401(k)s and how this could help or hurt your retirement savings.
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Investment Managers Encouraged
Investment management firms that provide retirement plan services are optimistic about the rule change.
“We’re really encouraged by what the administration is doing to help secure better retirements, especially their focus on increasing access to lifetime income options,” said Colbert Narcisse, chief product and business development officer at Teachers Insurance and Annuity Association of America, in an email.
Narcisse added that TIAA and its asset management unit, Nuveen, see the executive order as an important step toward helping to ensure retirees don’t run out of money.
There’s not universal agreement on that outcome, however.
Concerns Over Higher Costs for Retirement Savers
In July, Massachusetts Sen. Elizabeth Warren sent a letter to the CEO of Empower, which serves as a record keeper and administrator for about $1.8 trillion in 401(k) plan assets. In the letter, Warren expressed concerns about private equity’s high fees, performance record and lack of transparency.
Financial planners share some of those concerns. “As for risk, the types of investments likely being offered would be a fund of funds, which would reduce the idiosyncratic risk of being invested in a private equity (or) private credit investment,” said Kevin Thompson, president and CEO of 9i Capital Group in Fort Worth, Texas, in an email.
“So, the risk should be curtailed to a degree, but the fact remains that these investments would not only have more risk than a traditional index fund but come with more cost to the end client, as private equity and private credit are much more costly than your typical investment strategy,” he added.
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Originally for Sophisticated Investors
Private equity and other private market vehicles weren’t initially intended for individual investors such as retirement savers. That can add to their inherent risk.
“Alternatives were built for institutions with in-house due diligence teams and long time horizons,” said Patrick Kennedy, founding partner at AllSource Investment Management in Hartford, Connecticut, in an email.
“While access has broadened — first to qualified purchasers with $5 million plus in investable assets, and now to 401(k)s — the product structure hasn’t fundamentally changed to support less sophisticated investors,” he added.
Powerful Investments, But With Caveats
Kennedy cautioned that these investments can be powerful additions to a retirement portfolio, but they are not plug-and-play mutual funds in the way many typical equity or fixed-income funds are.
Even high-net-worth investors rely on experienced advisors to navigate these allocations, he said.
“For everyday savers, introducing these products into retirement accounts without sufficient education or guidance could be a setup for misaligned expectations, or worse, real harm,” Kennedy said.
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New Rule Doesn’t Mean Going All-In
Phillip Senderowitz, managing director of Strategic Retirement Partners in Orlando, Florida, said investors should keep in mind that the addition of private equity to 401(k) plans isn’t an all-or-nothing decision.
“Lost in much of the discussion is that this change won’t result in individuals putting all of their retirement savings into a single alternative asset,” he said.
“The intent is to give professionally managed portfolios inside retirement plans the ability to include these asset classes as part of a broader allocation, similar to how pension funds and endowments have invested for decades,” he said.
When used this way, alternatives can expand diversification and provide access to strategies that have historically delivered strong results over the long term, Senderowitz said.
“The real impact depends on skilled fiduciaries, using them thoughtfully to align with retirement savers’ long time horizons,” he added.
Safety and Transparency
Private investments can be harder to sell and less transparent. However, in a 401(k) plan, they would be included in a fund, not available as standalone investments.
Within that wrapper, investors should understand what they own, as with any other fund in their 401(k) account.
However, plan administrators, who choose which funds are available to participants, must take steps to be sure they are adhering to their fiduciary duty when offering private market investments to retirement savers.
Fiduciary Responsibility
“As a plan administrator and fiduciary, I have to be responsible for what is added to the plan,” Thompson said. “I would need to vet these investments and make sure they fit the plan profile prior to putting them into a 401(k) plan.”
That means plan fiduciaries are responsible for doing the proper due diligence to make sure investors are protected.
“On top of that, from an investor perspective, you need to know what you are buying and why,” Thompson added. “Actually knowing what companies are within that investment and how the lock-up periods work is crucial.”
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More Risk and Higher Fees: How Trump’s Private Equity Push Could Impact Your 401(k) originally appeared on usnews.com
