 |
| Joe Raedle/Getty Images |
President Donald Trump has signed an executive order that may bring sweeping changes to how Americans save for retirement and potentially introduce higher risk into portfolios that are meant to be safe.
According to White House officials, the new order will open the door for alternative investments, such as private equity, to become part of standard 401(k) retirement plans. While private equity was once the domain of institutional investors and the ultra-wealthy, the order could soon make these complex assets available to everyday workers.
But not everyone sees this as good news.
Investment experts are voicing concerns, pointing out that 401(k)s are typically designed to be low-cost and relatively low-risk vehicles, while private equity funds tend to be illiquid, hard to value, and loaded with high fees. Moreover, private equity returns can vary dramatically depending on the market cycle.
“Private equity kind of always gets what it wants in Congress, but I think it's a bad idea,” said Jeffrey Hooke, a professor at Johns Hopkins Carey Business School. “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,” he added.
1. An Inevitable Development
The move to include private equity in retirement accounts reflects a larger trend of blending public and private markets, particularly as traditional exit opportunities for private equity firms become more constrained.
During the pandemic, the private equity sector boomed, snapping up companies using cheap debt. But in today’s higher interest rate environment, dealmaking has slowed, and funds are seeking alternative ways to generate liquidity such as tapping into the $12 trillion 401(k) market.
“It’s an exit ramp for the current situation going on for private equity,” said Brian Payne, chief private markets and alternatives strategist at BCA Research.
Exit options like IPOs, acquisitions by public companies, or sales to other PE firms have stalled. A recent PwC analysis estimates that 4,000 to 6,500 private equity exits have been delayed in the last two years. These delays have created pressure as limited partners begin demanding capital distributions, forcing private equity firms to look for new sources of liquidity.
With few exit strategies available, firms have lobbied the Trump administration to gain access to retirement vehicles a massive pool of long-term capital. And it’s not just private equity. Experts like Hooke believe that private credit and real estate alternatives are next in line to enter the retail investment space.
2. Higher Risks for Everyday Savers
Private equity has historically outperformed the public market, but largely due to the illiquid nature of its investments, which are often locked up for 10 years or more. However, retail investors typically demand more liquidity, and that, according to Payne, will dampen returns.
Plus, private equity is known for charging high management and performance fees, which can eat away at overall gains.
“It'll make the retirement plans suboptimal,” said Hooke. “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 portfolios are designed for long time horizons, Payne warned that in an economic downturn, job losses could cause people to tap into their 401(k)s prematurely, creating a liquidity mismatch and posing systemic risk.
This concern is shared by Moody’s Investors Service, which recently flagged that allowing retail participation in private markets could pose financial stability risks, especially if markets become stressed and investors demand redemptions from illiquid positions.
Though critics worry about the risks, the overall impact may be moderate at first. Analysts expect only about 10% of retirement assets to flow into private equity over time which could mitigate the impact of volatility or losses for the broader public.
Still, corporate sponsors the employers who offer 401(k) plans may be reluctant to take on the reputational and fiduciary risk of offering opaque, high-fee private equity funds.
“When you get retail involved in opaque markets, with very different liquidity structures, very different risk, and ultimately different assets and strategies, it doesn’t end well,” Payne concluded.
Trump’s executive order is a landmark shift in how retirement savings could be managed in the U.S., offering more options but also more complexity and potential risk for American workers.
As private equity gains access to the 401(k) space, investors should keep a close eye on fees, liquidity, and market risk, and employers may need to weigh carefully whether to introduce these alternative assets into their plans.
For those saving for retirement, the old investing rule still applies: understand what you're buying especially when your future depends on it.
