Private Equity Is Coming for Your 401(k)

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1:37One day in January, less than a week before President Trump's second inauguration, a group of more than 30 money managers hopped onto a Zoom call. It included representatives from Blackstone, UBS, and other big Wall Street firms. It was sort of a meeting of like-minded individuals to strategize about, I guess goals would be a way of putting it that they have in common. Allison McNeely covers the private equity industry for Bloomberg. One key principle I think that folks were coalescing around was the idea to get more private equity, private credit, hedge fund, that sort of thing, into the retirement accounts of everyday Americans.

2:17They wanted a piece of the 401k. It's kind of the next gold rush. For a long time, private equity firms have relied on capital from pension funds, endowments, and other kinds of professional investors to sustain their growth. But now, these firms are looking to explore new frontiers. Potentially very lucrative frontiers. There's about$12 trillion in employer-sponsored accounts like 401k plans. That's only expected to grow? Those funds don't generally have private assets in them. So if they can grab even a slice of that, that's a few trillion right there. And when they gathered on that pre-inauguration Zoom call, the industry's biggest players agreed now is the time to start grabbing slices.

3:02What was the vibe like? The vibe was definitely optimistic. You know, there's a sense in the industry that now is the moment to strike. 401ks and the goal of getting into 401ks is an extension of a broader theme that really has been taking place over the private equity industry for many years. Now, the traditional sources of capital have been tapped out, but these private equity firms are still looking for ways to grow. And so what's a market that they haven't really tapped before? Regular people.

3:36This is The Big Take from Bloomberg News. I'm Sarah Holder. Today on the show, President Trump has signed an executive order allowing private equity into Americans' retirement plans. What's behind P.E.'s play for the 401k? How likely is it to work? And what would it mean for your savings?

4:00Let's say you're an employee working at a company that offers 401k retirement plans. You may not know exactly what kinds of investments are in the retirement plan you choose. I barely know what's in my 401k, to be quite honest with you. People tend to pick from a few default pre-mixed options. And that's what makes the job of selecting what goes into those 401k offerings so important. They basically have a responsibility to you, me, to other employees under federal law to essentially pick safe or responsible investments for us to choose. Traditionally, that's meant a 401k is invested in a mix of stocks and bonds.

4:41The classic portfolio would be 60 % stocks, 40 % bonds. A lot of people are invested in what's called a target date fund. So basically, you kind of pick the fund with the retirement date closest to when you think you're going to retire. I think I'm in like a 2055 fund. I'm in my late 30s, so to give you an idea. Right now, that fund is almost entirely in stocks. And as they get closer to retirement, that fund will shift into bonds because bonds are perceived to be safer. But stocks and bonds aren't the only kinds of investments a 401k could include. There are folks who say, no, actually, like private equity is a totally valid and legitimate option as well that just hasn't been offered so far.

5:22They would like to see essentially my 2055 target date fund take a slice out of stocks and bonds and instead put it into private equity funds. Can you explain how private equity firms work and why they aren't typically offered as an option? Yeah, so private equity, we're really using a simplistic term to sort of describe the broader industry. It's about$25 trillion in assets of private assets. So equity, debt, real estate, basically they don't trade on a stock exchange. They're sort of bought and held for the long term. Generally, when you invest in a private equity fund, you're handing over a chunk of change to that firm for 10 years.

6:08You're saying, I'm going to give you a check for$100 million to invest in your latest fund. And you're going to go out and buy companies, turn them around, and then hopefully, ideally, sell them at a profit sometime in the next 5 to 10 years. In the meantime, I don't expect to get my money back. Private equity firms typically make their money by buying a company, usually with debt. They try to maximize profits, cut costs, and eventually sell it for more than they bought it for. This setup means private equity investments are less liquid. It's harder for an investor to cash out if the firm hasn't yet turned around a business or flipped it.

6:44And now, higher interest rates and declining asset values have meant fewer sales, which means investors aren't getting their money back, which chokes off that cycle of reinvestment. It's a big motivation for this push to tap new pools of cash, like retirement savings. But for investors, being exposed to private equity comes with risks. There's a chance it might go bankrupt. There's a chance this turnaround plan or this sort of value creation plan you have might not work out. That is very different from investing in the stock of a big publicly traded company where you're a shareholder and you're one tiny, tiny, tiny little slice of all these other public shareholders.

7:25where you can go and log into your brokerage app and buy and sell that stock whenever you want. They're just sort of perceived as a higher risk, higher return investment. And so in the past, they've been restricted only to professional investors who kind of know what they're doing, you know, pension funds, endowments, that sort of thing. What about fees? Are PE fees higher than other investments? Yes. Private equity fees are typically what they call 2 in 20. And so that basically means that the private equity firm takes 2 % of whatever you give them as a management fee. That's just the money they make for managing your money.

8:01And then the 20 % is that they take 20 % of any profit that they make. The average ETF fee is closer to 0.44%, significantly lower than the average P.E. fee. These risks and fees have so far turned off 401k managers. Today, fewer than one in 10 401k plans offer any kind of alternative investment, according to a survey from the American Retirement Association. Of those that do, less than one in four include private equity in the mix. But private equity proponents argue these risks are worth it for the potential rewards. Walk me through some of the arguments that private equity managers use for including private equity in 401k offerings.

8:49Yeah, so they say they beat the S &P 500, and they might have a point there. You know, if you want to broaden your exposure away from sort of the biggest tech stocks, away from the volatility of public markets, they might have an argument for that. But there's also a counter argument. Well, you're going into investments that are a lot more opaque, that are not valued on a daily basis. there's a little bit more art as to how they're valued and how they're traded and what they might be worth and who might want to buy them from you. Because, you know, with a private equity investment, the only way you make money if you buy a company is if you can find someone else to sell that company to.

9:33And that is actually a challenge that we've seen the private equity industry go through in the last couple of years. Higher interest rates, more expensive debt has made it harder for private equity firms to sell a lot of these companies that they've invested in. And so there is something to be said about also being able to get in and out of, you know, meta stock, knowing exactly what it's worth, knowing that someone will buy it from you. Still, people pushing to get private equity into 401ks say that the fact that these are longer term, less liquid investments is actually a good thing. Apollo Global Management CEO Mark Rohn is an example of this.

10:10They're a large private equity firm. They say that actually private assets, because of the long-term investment horizon of retirement, it's a perfect match. Because you don't need your money for 20, 30, 40 years, you don't actually need to be all in stocks and bonds and things that can be sold on demand whenever you want on a daily basis. Right. You don't have to buy today, sell it tomorrow. You have to buy today, sell it in 30 years or 40 years. Exactly. And by taking, you know, a smaller portion of your portfolio, some people say 10 percent, some people say 20 percent. By taking a portion of that and instead putting it in a private equity fund that, yes, is a little bit riskier but has a potential for higher return, it's actually smart.

10:55And if you don't do that, you're leaving money on the table. A lot of people who are proponents of putting private investments such as private equity into 401ks say the best way to do it would be as part of a diversified portfolio like a target date fund. And so it's basically like the asset mix would change over time. There are some people who still say, I don't know, like that's still it's really difficult to determine how like the liquidity, as they call it, will really work. If people will really be able to get out of these things if they need to, if the asset mix is really appropriate. Like these are still live questions that people are trying to solve.

11:35Part of the reason we don't know the answers to these questions yet is because private equity's share of American 401ks is tiny. Trump's executive order will change that. After the break, the political shifts that could help P.E. capture investments from regular people.

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13:38401ks were invented some 50 years ago to help workers avoid paying taxes on deferred compensation. That evolved into a way for employees to save for retirement without employers having to offer a traditional pension. The number of people enrolled in 401ks and similar retirement plans has steadily grown. And companies are required to act in their employees' best interest when selecting the breakdown of their 401k offerings. Basically, retirement law says the fiduciary has a sort of responsibility to pick the most prudent investment for their plan participants. They don't really say what prudent means, and so people have taken a really conservative interpretation of that.

14:22Bloomberg's Alison McNeely says that requirement is one reason many employers have shied away from including private equity in their plans. There's a lawsuit that a lot of people in and around the industry invoke, which is the Intel lawsuit. Intel was sued about a decade ago after Intel put some private equity funds and some hedge funds into its 401k plan. Some of those employees sued the company. They said, you put our plan into these private assets at the time that public markets were on a tear and we actually missed out on the market rally. You didn't manage my money correctly by investing in private equity.

15:02Yeah. And so that lawsuit really created a chilling effect in the industry because other companies don't want to get sued. And they just basically want to know that if they were to allocate some of their 401k into private investments, that they wouldn't get sued. And also, even if they do get sued and defend themselves, there's still a lot of headline or reputational risk there that many of these companies that are conservative by nature and want to protect their reputations would like to avoid. That Intel case over its 401k strategy was eventually dismissed. The plaintiffs are trying to get that dismissal overturned on appeal.

15:44But some employers are waiting for a more definitive sign that exposing their employees' 401ks to private equity won't get them into trouble. I think a lot of corporate 401k plan administrators are looking for a green light from the government that they won't be sued if they put alternative assets into their retirement plan. The way the law is right now is it's kind of silent. Technically, from a legal standpoint, there's nothing preventing a company from putting private equity in their 401k plan, provided they've done their due diligence and run their process to make an appropriate investment.

16:30It's really sort of a hearts and minds debate or argument or fight as much as anything else. With Trump in the White House and Republicans in control of Congress, private equity advocates have been waiting for the moment they get more clarity from the federal government. The first Trump Department of Labor did put out a letter that says we think that private equity has a role in 401ks. So that was a pretty clear signal back in 2020 that, you know, folks could possibly go ahead with this. Is there evidence that employees would opt into those plans? I don't think there's a sense at this point that employees are clamoring for private assets, but maybe they will in the future.

17:12Right. For some people, private equity doesn't have the best reputation. They see headlines about its negative impact on sectors like health care and housing. I guess what I'm asking is, do you get the sense that some workers would want to avoid having their 401k tied up in private equity for ethical reasons? It's a really good question. There are people who don't like private equity, who don't like the impact private equity has had on health care and other industries, and they might object to having their 401k invested in that. But if it's part of a target date fund, it's sort of being offered to them as part of a broad portfolio, they might not even be able to opt out of it.

17:51Like, at this point, we don't really know.

18:02This is The Big Take from Bloomberg News. I'm Sarah Holder. To get more from The Big Take and unlimited access to all of Bloomberg.com, subscribe today at Bloomberg.com slash podcast offer. If you liked this episode, make sure to follow and review The Big Take wherever you listen to podcasts. It helps people find the show. Thanks for listening. We'll be back tomorrow.

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