Private Equity Could Be Coming to Your 401(k) Program

Summary

WSJ Your Money Briefing — "Private Equity Could Be Coming to Your 401(k) Program"

Date: June 25, 2020
Host: J.R. Whalen, The Wall Street Journal
Guest: Ann Tergeson, WSJ Retirement Reporter

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Episode Overview

This episode delves into the Labor Department's recent decision to allow private equity investments to be included in 401(k) retirement plans. Host J.R. Whalen and reporter Ann Tergeson break down what this means for American workers, the potential risks and benefits, and the logistics of how private equity could fit into the average retirement portfolio. The conversation is timely, as it follows new government guidance and growing interest in broadening retirement investment options.

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Key Discussion Points and Insights

1. Understanding Private Equity in the 401(k) Context

• Illiquidity and Risk:
  Ann Tergeson explains that private equity is an illiquid, higher-risk investment not traded on public markets.

  "You might actually face long, what they call lockup periods of several years where you can't cash in your investment. So they have a higher risk level than publicly traded equities do." — Ann Tergeson (00:48 – 01:10)

• Potential for Higher Returns:
  While riskier, private equity is seen as potentially offering higher returns, at least in theory.

2. Labor Department's New Guidance (01:49)

• How the Change Happened:
  The decision came in early June as a response to private equity firms seeking clarity about inclusion in 401(k)s. The Labor Department said yes, but with constraints:

  “It should be included in a professionally managed fund like a target date fund... plans need to do what pension funds have done, which is professionally manage a portfolio for people that might include a small amount of private equity.” — Ann Tergeson (01:49 – 02:24)

3. Why Private Equity Hasn't Been in 401(k)s Until Now (02:29)

• Employer Hesitation:
  Traditionally, 401(k) options have stuck to "plain vanilla" investments like stocks and bonds due to employers' concerns about exposing employees to potentially risky, complicated investments.

  “Employers are always very worried about giving employees choices that may blow up on them.” — Ann Tergeson (02:29 – 03:09)

4. What Do Private Equity Funds Invest In? (03:37)

• Exposure to Private Companies:
  Private equity invests in privately held companies, expanding potential portfolio diversity, especially as the number of public companies has declined.

  “A greater percentage of the US economy is composed of privately held companies... average investors should be given the opportunity to have exposure to that rather than just the wealthy.” — Ann Tergeson (03:37 – 04:24)

5. Where the Big 401(k) Administrators Stand (04:29)

• Current Reluctance:
  Major players like Fidelity, Vanguard, and T. Rowe Price are evaluating the possibility but have no immediate plans to include private equity in their funds.

  “As of this moment, none of them have exposure to private equity and none of them have any plans to add it in the short term.” — Ann Tergeson (04:29 – 04:58)

6. How Would Investors Choose Private Equity? (05:03)

• Limited Control for Employees:
  Private equity, if offered, will be a component within professionally managed funds like target date funds. Employees can't opt to invest directly in private equity through their 401(k)s.

  “If you go into the Target Date Fund and it offers private equity, you will have some, probably pretty limited, maybe a couple percentage points of your money will go into private equity.” — Ann Tergeson (05:03 – 05:48)

7. Fees and Legal Concerns (05:51)

• Fee Sensitivity and Litigation Risk:
  High fees are a significant concern, and many large 401(k) plans face lawsuits about excessive fees, making employers wary of costly investment options.

  “When a lot of employers look at this, they get nervous about anything that has sort of higher fees.” — Ann Tergeson (05:51 – 06:27)

8. The Type of Investor Best-Suited for Private Equity Exposure (06:34)

• Target Date Fund Dynamics:
  Most investors in target date funds are looking for a set-it-and-forget-it solution. More engaged investors should research any private equity options and their track records before participating.

  “If you are a young investor and very engaged... I think you should try to think about whether private equity makes sense to you.” — Ann Tergeson (06:34 – 07:24)

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Notable Quotes & Memorable Moments

• On inclusion in target date funds:

  “The vast majority of investors in Target Date funds are generally people who just want their employer to kind of do this for them.” — Ann Tergeson (06:34 – 07:24)

• On employer caution:

  “Employers are always very worried about giving employees choices that may blow up on them.” — Ann Tergeson (02:29 – 03:09)

• On the arguments for using private equity:

  “A greater percentage of the US economy is composed of privately held companies... average investors should be given the opportunity to have exposure to that rather than just the wealthy.” — Ann Tergeson (03:37 – 04:24)

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Essential Timestamps

• 00:48 — Explanation of what private equity is and its illiquidity and risk profile.
• 01:49 — Labor Department’s new guidance and rationale.
• 02:29 — Why private equity hasn’t been in 401(k)s previously; employer concerns.
• 03:37 — What private equity funds invest in and the argument for broader access.
• 04:29 — Where major fund managers stand.
• 05:03 — How (and if) 401(k) investors can select private equity.
• 05:51 — Fees and legal risks associated with private equity in 401(k)s.
• 06:34 — Advice for hands-on investors and considerations for target date fund participants.

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Summary Takeaway

The episode highlights a potential paradigm shift in retirement investing: while private equity could offer new diversification and higher returns, it comes with increased risk, limited liquidity, and likely higher fees. Its inclusion will be tightly managed—likely only accessible within target date funds and only as a small part of the portfolio. For most 401(k) investors, especially those who prefer automatic solutions, little will change soon. More engaged, risk-tolerant participants may see opportunities emerge but need to proceed carefully and do their homework. Employers and plan administrators remain cautious, with major providers not yet embracing the change.

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Transcript

[A]

This episode is brought to you by Charles Schwab. Decisions made in Washington can affect your portfolio every day, but what policy changes should investors be watching? Washington Wise is an original podcast from Charles Schwab that unpacks the stories making news in Washington right now and how they may affect your finances and portfolio. [e-mail] WashingtonWise.

[B]

Here's your money briefing for Thursday, June 25th. I'm J.R. whalen for the Wall Street Journal. 401k retirement plans typically give you a list of what kind of investments you want to include in your account. The Labor Department recently indicated you could see another riskier option soon, private equity.

[C]

Private equity generally, I mean, they're illiquid investments. They're not publicly traded. So if you want to go and sell your private equity, you can't necessarily do that. You might actually face long, what they call lockup periods of several years where you can't cash in your investment. So they have a higher risk level than publicly traded equities do. And, you know, in theory, they have a higher return.

[B]

So what does private equity invest in? And who decides whether it'll be offered by a 401k? Our reporter Ann Tergeson will be here with some answers after the break. Private equity funds have been a mainstay of pension programs programs for decades. Soon they'll be an investment to consider in your 401k plan. But is private equity right for everyone in how do 401k administrators feel about it? Let's bring in retirement reporter Ann Tergison for some answers. So, Ann, how did this come about, you know, private equity funds potentially able to be a part of 401k programs.

[C]

In early June, the Labor Department issued a letter in response to two private equity firms that were basically asking for guidance. You know, they were basically saying, like Labor Department, is it okay if 401 plans offer private equity? And the response from the Labor Department was yes, but it should be included in a professionally managed fund like a target date fund. So the guidance from the labor department was that 401 s need to do kind of what pension funds have done, which is, you know, professionally manage a portfolio for people that might include a small amount of private equity.

[B]

Now why hasn't private equity been available for investment by 401 s up to this point?

[C]

Well, generally, 401ks have stuck to stocks and bonds, sort of plain vanilla investments. And it's not really clear. I mean, it's just a relatively new area versus pension funds that have been more established over time also 401k plans, they're offered by employers. But historically the employees have gotten to choose the investments that they want. And employers are always very worried about giving employees choices that may blow up on them. And if, if an employer were to offer an employee sort of a standalone private equity fund, you know, that could be like a very risky thing to put all your money in. So I think employers have been sensitive to that.

[B]

Now, what's the risk reward profile associated with private equity?

[C]

Private equity generally, I mean, they're illiquid investments. They're not publicly traded. So if you want to go and sell your private equity, you can't necessarily do that. You might actually face long, what they call lockup periods of several years where you can't cash in your investment. So they have a higher risk level than publicly traded equities do. And you know, in theory they have a higher return.

[B]

And what do private equity funds invest in?

[C]

They invest in private companies. So you look at like Amazon or Apple or whatever, Google, and you can buy and sell those shares daily on the stock exchange. But there's a Large Percentage of U.S. companies that are privately held. You know, they're owned by the people who started them. Maybe, you know, these can even be some very large companies. They, they're just not traded publicly. And in the last 20 years, the number of companies that have listed on the public exchanges has actually declined. So part of the argument for adding private equity is that a greater percentage of the US Economy is composed of privately held companies. And so average, you know, investors should be given the opportunity to have exposure to that rather than just like the wealthy.

[B]

So are the biggest 401k plan administrators on board with including private equity as an investment option?

[C]

Well, the three biggest target date fund managers are Fidelity, Vanguard and T. Rowe Price. And you know, they say that they have in the past kind of looked at private equity and the possibility of adding it. And you know, they continue to sort of evaluate private equity, but they don't have any immediate plans to add it. So, you know, it's hard to say what they're going to do in the future. But you know, as of this moment, none of them have exposure to private equity and none of them have any plans to add it in the short term.

[B]

So are there any steps that 401 investors can take if they want to have private equity as an option?

[C]

No. So what will happen here is that if a 401k plan decides that it wants to offer private equity, it's going to do that within its Target Date Fund and the plan together with, you know, its consultants, or they're going to figure out how much private equity exposure they want participants to have at various ages. And you know, you are going to have a choice whether you want to be in the Target Date Fund or not. So if you go into the Target Date Fund and it offers private equity, you will have some, probably pretty limited, maybe, you know, a couple percentage points of your money will go into private equity. And if you decide, you know what, I don't want to invest in the Target Date Fund, then you will not be able to invest on your own in private equity within your 401 plan.

[B]

And what kind of fees are carried by private equity?

[C]

Right, so that is one of the potential headwinds to private equity in 401k plans is there are a lot of lawsuits, particularly against companies with very large 401k plans. And a, a lot of these lawsuits allege that fees are too high, they should be lower. And so, you know, so that when a lot of employers look at this, they get nervous about anything that has sort of higher fees. And with the movement towards index funds, you've seen fees just go down, you know, across the board on mutual funds in 401ks. So, yeah, that's a big headwind. The litigation is.

[B]

Now you mentioned there can be quite a lot of risk involved when private equity becomes an option in 401s and investors really would have to do some homework.

[C]

You know, in that case, an investor who really is very hands on, sometimes those, those investors don't necessarily want to go into a Target Date fund. Often the Target Date Fund captures like, you know, the vast majority of people who really are sort of like, please just do this for me. I don't want to have to make decisions. But that doesn't, you know, I mean, if you are a young investor and you're very engaged and you're, you're wondering, you know, whether you should go into the Target Date Fund or not and it has private equity in it, then yes, I think you should try to think about whether private equ makes sense to you. And you might want to do some research on who are the private equity funds that your employer has selected to be in the plan. And it's hard to find track records, but you might want to look into things like that too. The vast majority of investors in Target Date funds are generally people who just want their employer to kind of do this for them.

[B]

All right, that's Wall Street Journal reporter Ann Tergeson. Ann, thanks for coming on the show.

[C]

You're welcome.

[B]

And that's your money briefing. Hi, I'm J.R. whalen for the Wall Street Journal.

[A]

This episode is brought to you by Charles Schwab. Decisions made in Washington can affect your portfolio every day. But what policy changes should investors be watching? Washington Wise is an original podcast from Charles Schwab that unpacks the stories making news in Washington right now and how they may affect your finances and portfolio. [e-mail] WashingtonWise.