MATT LEWIS | PRESIDENT, WESTERN GROWERS FINANCIAL SERVICES FINANCIAL SERVICES
401(k) Plans Can Now Invest in Private Equity Funds As part of the Trump administration’s trend toward deregulation, the U.S. Department of Labor (DOL) recently issued guidance allowing companies to include certain types of private equity funds in 401(k) plans, investments that have traditionally been reserved for the wealthy few.
What is Private Equity? Simply put, private equity refers to investments in companies that are not publicly traded. Leveraged buyouts and venture capital are familiar types of private equity investments, which come primarily from institutional and high net worth investors. Generally speaking, private equity requires investing substantial sums of money, which is then held for extended periods of time and used to fund growth through new technology, acquisitions or working capital. Usually, the end game for private equity is some type of a liquidity event, such as an initial public offering (IPO) or a sale to a public company. Arguments in Favor of Private Equity in 401(k) Plans Proponents of allowing 401(k) plans to invest in private equity point to access, diversification and higher returns for the average investor. Indeed, 98 percent of U.S. households currently cannot invest directly in private equity, according to the Committee on Capital Markets Regulation, an independent research organization. In his announcement, Scalia claimed that opening up private equity to 401(k) access “helps level the playing field for ordinary investors,” and ensures that “ordinary people investing for retirement have the opportunities they need for a secure retirement,” placing them on par with wealthy and institutional investors. As the argument goes, adding an additional asset class for the average investor is important now more than ever. According to a study conducted by Credit Suisse, the number of companies listed on the U.S. stock exchange has fallen by 50 percent over the past two decades. The number of IPOs annually have also dramatically fallen since the dotcom boom, down from a peak of nearly 700 in 1996 to just 100 in 2017. Private capital markets have been picking up the slack, which means the average investor has been locked out of where the action is increasingly taking place, and where impressive returns are being made.
In a statement announcing the decision, Labor Secretary Eugene Scalia argued that private equity will “help Americans saving for retirement gain access to alternative investments that often provide strong returns.” Not everyone shares Scalia’s enthusiasm. Opponents of the decision, including many Democrats and consumer groups, hold the view that private equity has no place in retirement plans, and contend that the average 401(k) participant will not understand the increased risk of this investment instrument. While opinions are mixed, even among investment professionals, the reality is that previous barriers restricting regular investors from participating in private equity funds have been removed, effectively opening the industry up to the $6.2 trillion 401(k) market. Before we look at the arguments for and against allowing 401(k) plans to invest in private equity funds, let’s first understand the term private equity.
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JULY | AUGUST 2020
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