The Department of Labor (DOL) recently issued guidance allowing employers to add retirement funds into their 401K investment lineup that invest in private equity. Private-equity funds, which fall into the broader category of alternative investments, have only been available to more affluent and institutional investors in the past – at least $200,000 in income in recent years or net worth of at least $1 million, not including a home. This is no longer the case.
Private equity funds, which invest in companies that aren’t listed on stock exchanges and therefore don’t have to report their finances or operations publicly, are among the riskiest and most opaque investment vehicles devised by Wall Street. They often saddle the acquired companies with heavy debt, diminishing their long-term prospects even as they produce short-term profits for the promoters. And their capital may be tied up in illiquid investments that make it hard for clients to get their money out when they wish.
Why would this be a good thing for retirement savers? For long-term savers, access to different types of alternatives (including private equity, commodities, hedge funds and venture capital) can be an important part of one’s retirement portfolio – is the rationale from the Department of Labor.
Future Wealth’s View
The Department of Labor (or the Department of Dangerous Ideas), in allowing private equity into 401K, has opened a can of worms that will result in a massive addition of regular folks to the list of those who do not have enough savings to last through their retirement years. Already, there are millions who do not participate in the 401K program at work. By allowing private equity options in a 401K, DOL has all but ensured that those who do save via the 401K could also end alongside those who didn’t save to begin with.
The private equity sector’s claim to produce returns superior to those of conventional stocks and bonds has been regularly questioned. Whatever gross returns are enjoyed by private equity firms are eaten away by the fees, typically 2% a year on total assets plus 20% of profits. And it gets worse. Private equity throws money into highly speculative investments that are really suitable only for persons who are willing and able to assume the risk of losing their entire investment. They are illiquid, lack a market to trade and involve myriad opaque asset-based, performance and other fees and expenses. If those reasons are not enough to stay away from, private equity funds generally reserve the right to engage in borrowing, or leverage, on a moderate or unlimited basis and are largely “unconstrained” and may change investment strategies at any time.
DOL should have kicked these private equity guys and their lobbyists out of their offices forever. Instead, they opened the door and welcomed them to raid the 401K of the average investor.