In a business sense, it’s as controversial as reneging on DACA or ignoring the virus. The Trump Administration wants to let some of your 401(k) money go into private equity.
In theory, this could work. If you directed the money, investing only what you were willing to lose, you might get into great deals. A young investor might, for instance, put a small portion of his money into a crowdfunded start-up.
Naturally, that’s not how the Trump Administration is doing it. Instead, the Administration is telling plan managers they will be legally protected if they take some of your retirement money to the dog track.
At his 2019 annual meeting, Berkshire Hathaway (NYSE:BRK.A) CEO Warren Buffett slammed the private equity market for high fees and opaque terms. Those sharks are now welcome to feast at your retirement’s table.
You may not find out about it until your retirement savings are gone.
401(k) – Yours, Not Yours
While the money in a 401(k) plan is legally yours when you retire, that is not how the funds are handled.
Many companies offer a single plan, or set of options, which are defined and controlled by an investment fiduciary. Fiduciaries are supposed to be knowledgeable. They’re supposed to understand risk. They’re supposed to focus on safety.
But M.I.T. and Oracle (NASDAQ:ORCL) are just two employers that recently settled lawsuits that alleged they breached this duty. This was in the public market, where Fidelity put employees into what were later called high-cost funds. Now private equity mavens are being invited to pitch them.
My wife’s employer , for instance, offers a small collection of plans it defines based on age and risk. The plan for a 55-year-old carries less risk than one for a 30-year old. But what goes into that plan is up to the fiduciary. A few years ago, her employer changed the fiduciary to Fidelity. She had no choice in the matter.
There are self-directed 401(k) plans but workers are warned away from them. These can already invest in assets as diverse as real estate and tax liens. In theory, they can now invest in private equity. You still must go through a plan administrator. There are still going to be fees.
There are also investments a self-directed plan can’t make, deals with family, with yourself, or with the plan administrator, called “disqualified persons.” That’s why you’re warned away from self-directed plans. It’s caveat emptor in a game where you don’t know all the rules.
To the Dog Track
The idea behind the new Department of Labor rule is that a fiduciary might put up to 15% of a plan’s assets into private equity deals. The fiduciary is supposed to manage the private equity partner. Lawyers say the new rule offers “comfort” to fiduciaries.
Private equity managers insist this is no big deal. Some pension plans already put client money into private equity deals. A good private equity fund can earn returns of 16%. But 10% of such funds have had negative returns over 10 years.
Negative returns are fine if you’re a rich dowager playing with corporate money you can lose. That’s not true if you’re the security guard at the rich dowager’s offices. But now, if she’s the fiduciary for the guard’s 401(k) plan, she can throw his money into the pile.
The Bottom Line
If a fund limits its participation to 15%, and only uses money from aggressive plans held by younger workers, this might work. But shares in Carlyle Group (NASDAQ:CG), Apollo Global Management (NYSE:APO) and Blackstone Group (NYSE:BLK), the largest private equity sponsors, jumped on the news.
Edward Siedle, who writes about retirement for Forbes, says the new rules throw 401(k) retirements “to the wolves.” He sees private equity throwing their worst, most-opaque deals at 401(k) fiduciaries. He sees fiduciaries trying to play “catch up” with the funds of older workers and quickly losing it all.
Siedle sees a disaster in the making. I see a rule that will be reversed next year and a risk that smart plan fiduciaries will ignore.
Dana Blankenhorn has been a financial and technology journalist since 1978. He is the author of the environmental thriller Bridget O’Flynn and the Bear, available at the Amazon Kindle store. Write him at email@example.com or follow him on Twitter at @danablankenhorn. As of this writing he owned no shares in companies mentioned in this story.