Are Private Equity Funds the Next Big 401(k) Gamble? Wall Street Pushes Risky Investments Into Retirement Plans

The Trump Administration is working on regulations that would allow retirement plan providers to offer ordinary investors exposure to private-equity funds and several 'alternative investments.' It could be a few years before these investment options are available on 401(k) plans, financial experts and advisers are gauging whether the potential for higher returns with private equity in portfolios is worth it.

In general, private-equity firms acquire companies using borrowed money to refine them and sell them later at a profit. This financial model has generated massive gains for many high-net-worth individuals and pension funds in the years after the Global Financial Crisis. However, this investment option remained out of the reach of ordinary investors due to high fees and liquidity constraints.

State Street data showed that private equity outperformed the S&P 500 by 2.5 percentage points over the past two decades. Experts say that private equity offers diversification through access to returns from hundreds of companies with over $100 million (£74.4 million) in revenue before they go public. The growing dominance of private equity is also reflected in the fact that the number of US public companies has fallen by 50% since the 1990s, to approximately 4,000.

However, some experts pointed out that the private-equity advantage over the S&P 500 is only 0.4 percentage points in the past 10 years.

The 2010-2020 decade was a great period for private equity, as lower post-crisis interest rates drove massive returns. However, the rate surge since 2022 has compelled several fund managers to reprice asset values to reflect the new rates and lower profit margins on investments, according to Goldman Sachs' Mike Brandmeyer.

'The trend is clear: In recent years, the excess return in the private market has been diminishing,' according to Nan Zhang, global head of State Street's private capital index.

There is also an issue with accurately measuring returns from private equity investments due to a lack of transparency in reporting. While public stock fund returns are reported daily based on market movements, most private-equity funds report returns quarterly. Furthermore, the metrics they use differ from those of mutual funds. For instance, one metric is called the 'internal rate of return,' which indicates returns on investor money as it moves in and out of the fund. Some experts believe this metric can be inflated in multiple ways.

Another essential factor to consider before introducing private-equity investments in 401(k)s is the associated fees. Today, exchange-traded funds have significantly reduced investment fees, typically under 0.5%. According to the Investment Company Institute, 401(k) plan participants who invested in stock via mutual funds paid an average expense ratio of 0.26% in 2024.

However, the management fees for private equity investments generally range from 1.25% to 2% annually, with a 20% share of profits. Wall Street firms are lobbying hard for the introduction of private-equity options in 401(k), eyeing trillions of dollars in potential new business.

Disclaimer: Our digital media content is for informational purposes only and not investment advice. Please conduct your own analysis or seek professional advice before investing. Remember, investments are subject to market risks and past performance doesn't indicate future returns.