Private Markets in Retirement Accounts: A Skeptical Analysis

We delve into the controversial topic of allowing private equity, real estate, debt, and even cryptocurrency into 401k retirement accounts, offering a skeptical analysis of this potential shift in retirement planning.

• Government is willing to allow private markets and crypto in 401ks, though these options aren't widely available yet
• Private markets involve less transparency and liquidity than traditional investments
• Historically, private investments required accredited investor status, assuming wealth equals financial education
• Many wealthy individuals have fallen victim to investment scams like Bernie Madoff and FTX
• Employers may face significant liability if employees lose money in private market 401k investments
• Marketing tactics of private equity firms often create false exclusivity around their products
• Volatility measurements for private investments are misleading due to infrequent pricing
• Traditional portfolio optimization models may overweight private investments due to understated volatility
• Gating provisions in private investments could restrict access to retirement funds
• Education and proper sizing of allocations would be crucial if these investments become mainstream options
• Current recommendation is caution before jumping into private markets in retirement accounts

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Chapters

• 0:00 Introduction to 401k Alternatives
• 2:12 Private Markets and Investor Requirements
• 5:19 Liability Concerns for Employers
• 7:41 Marketing Tactics and Volatility Measurements
• 10:12 Caution and Final Thoughts
• 14:22 Episode Closing and Call to Action

Transcript

Steve Davenport: 0:26

Hello everyone and welcome to Skeptic's Guide to Investing. Today I'm here with Clem Miller and we don't have a guest. We've decided that it's time to get back to talking about markets and giving our skeptical views on things. So today's topic, the 401k. Is it a place for private equity, private real estate, private debt? How do we feel about alternatives in our 401ks? And I think I'm going to ask Glenn, because he loves markets and he loves equities and he loves the rest. So, Clem, are you going to be buying private real estate, private equity or private debt in your 401k?

Clem Miller: 1:11

So you know the thing well right now you just can't, okay, buy those things in 401ks this is a hypothetical question, but the government has said that they are willing to allow it and not just private markets, but also crypto as well in 401ks and of course, we all know that crypto isn't really an investment. So that is just insane to put people's retirement assets in crypto. So let's turn to private markets for a second private markets. The issue with private markets is that there's less transparency and there's less liquidity when it comes to private markets, and that's why uh, historically, and that's why, historically, you needed to be a qualified accredited investor, which means basically rich or richer, to be able to….

Steve Davenport: 2:25

Well, I'm told that if you're in Boston, New York or LA, having $2 million is not rich.

Clem Miller: 2:28

Just remember that. Okay, so neither of us is in Boston or New York. We may have the money, but we're not putting it in private equity, right, but private markets. The rules have been that you've got to be, you've got to be wealthy, and the presumption you know super wealthy, high net, high net worth, ultra high net worth to do to do private equity, to put it into your accounts. And the presumption is that you know if you have that kind of money, then you're educated enough to be able to make that kind of decision. And I don't know if I agree with that, because there are a lot of people out there who are very wealthy who don't have a clue as to what they're doing. Think of all the people who put money with Bernie Madoff right, who were fooled by him. Ftx, yeah, ftx. So there are a lot of wealthy people out there who just don't know what's going on. So this presumption that being wealthy is evidence of being educated in investments is just not accurate. But in any case, don't you?

Steve Davenport: 3:48

I think the fiduciary nature of 401ks will make it harder for some of the sponsors to put the I mean ultimately-. Well, yes, If you put it in there as a sponsor and it delivers horrible results for your employees, is there a liability at the company level? Is there a liability at the manager level? Is there liability at the manager?

Clem Miller: 4:11

So who's going to go after who government is going to be allowing these things to go into 401k accounts, but it's ultimately up to the employers themselves to decide what should go into those accounts. So what do you think as options?

Steve Davenport: 4:35

Let's just go to the end game here, which is something goes down 50% gets taken out 4,000 people invested over $20 billion. They lost $10 million of it. Who pays Clem?

Clem Miller: 4:55

So. So ultimately, employees themselves are going to get hit there's no question about that and employers if there's a problem with the private equity, private markets, crypto in 401ks, the employers are going to get sued by employees. There are plenty of law firms out there that sue employers on behalf of employees who've lost money in 401ks, and so they I mean, I've seen some cases are very simple and they didn't seem like the company did a lot wrong.

Clem Miller: 5:38

Yeah, Still paid a lot of money, so I think I think that a lot wrong. Yeah, he still paid a lot of money. So I think I think that a lot of companies, will not allow private markets and crypto as options in their 401ks a lot. Now, that being said, there are employers who have no idea what they're doing, right?

Steve Davenport: 6:06

Well, I mean the industry. There's two reasons why something happens, right that it generally comes down to is the government saying it's okay to do this? And are there companies who are in the private equity and private real estate space that that that are doing things that we should, we think are going to do them well and therefore we need to let them come to market?

Clem Miller: 6:36

and and you know well, the private equity companies I'm not going to name names, but you know there are companies out there that are really good at marketing and they market private markets in a sense to try to say, well, you know, to give it kind of a panache, right, oh, we're giving you the opportunity to invest alongside the, you know, the uber wealthy, right, we're giving you that opportunity to do that. I mean, that kind of statement alone should make you wonder, like, why are they giving me this opportunity to begin with? Right, it should make you think, right. So, so my concern is that you're going to have the private market investment companies with big marketing budgets going around selling these products, trying to create this image that this is the way to invest, the way to invest in the future, that they're going to cite the fact that the government's allowing it not just as allowance but as endorsement. Well, the government has told us all that it's OK to do this. The government wants us to invest in this right.

Steve Davenport: 8:12

Well, also Clem. I mean, as CFA's, we both got to say the way that they calculate their volatility, using quarterly numbers, versus daily numbers, right is completely different right. When they show you a volatility, the volatility is not actually the volatility. The volatility is dampened because of the way they price it right.

Clem Miller: 8:31

So there's no. It's not logical to put, it's not logical to look at sharp ratio and other things for private equity. It's not logical to try to put private equity into private markets, into an optimizer right, because that optimizer is going to look at the low volatility and it's going to give you a very high weight to private markets because of the lower volatility Right.

Steve Davenport: 9:01

And so I mean I look at this for investors and say it's on the radar, it's in the future. If you look down the road, this is a year, two year decision that you don't have to make yet. But in my mind we have to kind of be a little bit skeptical of the fact that this got through so quickly. And there's these groups of people, whether it's with Vance or other parts of the administration, that have been in that space and think, oh, that's a great space for everyone. And I think in reality we know that everyone who has a 401k now might not be the true audience for this, and we have to just be smart about whether we think these solutions are going to be good for everyone. I don't think they're necessarily going to be bad for everyone, but I think we're, way you know, we're in the early innings here, and so I think in the early innings I would just say Caution is the better part of discretion here.

Clem Miller: 10:09

I would say at this point if you're presented with that option of private equity, private markets in a 401k, I would say wait, don't jump on it right away. Away wait.

Steve Davenport: 10:27

I think it needs some time. I think this idea sprung out of you know, trying to support crypto and trying to help with stablecoin, trying to do a lot of things at one time, and I'm not sure you know. For a while it was talking about whether you should expose 401ks to IPOs or other companies, and then they said no, we should wait until the company is established in markets and part of a benchmark before we start to make you know that type of opportunity available. And I would say here we're going way beyond an IPO, because these are companies that are pre-IPO, these are companies that have not established themselves and have a higher failure rate. Therefore, yes, they have those cases where they can win, but it's most likely to be a portfolio of companies. It's most likely to be offered by very big firms who have very big marketing budgets, but also very big lawyers who are going to help them to develop and roll out a product that, in my mind, could look so different than the standard product that it might not be the same.

Clem Miller: 11:38

And, steve, you know some of these, some of these private markets products have gating in them right when you know gating for those of you who might not know what that is you know the private markets firms can say, well, you know that we're having a liquidity issue right now, so we're not going to let you take out your money, you know at on demand, or you know we may allow it to dribble out, you know once a quarter or whatnot. That kind of thing is just not, you know, is just not the kind of thing you can put into a retirement account, in my opinion.

Steve Davenport: 12:18

Well, I think you can put it there, but it has to be sized properly. It has to be understood. But it has to be sized properly. It has to be understood, it has to be in conjunction with all the other assets and so who's going to make that decision?

Clem Miller: 12:30

Joe Smith.

Steve Davenport: 12:33

Correct.

Steve Davenport: 12:35

It requires a lot more education, a lot more knowledge and a lot more ability to understand the risk you're taking.

Steve Davenport: 12:42

And if you have those things, it could work. But all I'm saying is it's a leap and I think before we leap we should look and look at what it is and look and understand it better. And I'm just saying let's have a degree of caution. And I think the 401k has done a good job for a lot of people, but is it the right place for private equity? It might be, but it's going to be a long time before the type of vehicle, the type of education and the type of plan sponsor who supports it is really organized in such a way that everyone in the 401k is serviced the same, the higher up executive to the factory worker. That's why 401ks have to be understood completely by everyone, because they're rolled out to the whole company, no matter what their graduation level is or what their degrees or certificates are, matter what their graduation level is or what their degrees or certificates are. So I would just say caution is the better part of valor. Yeah, Do you have anything you want to add before we wrap it up?

Clem Miller: 13:55

Nope, I think we've covered that one.

Steve Davenport: 13:57

All right, everybody. Please listen to Skeptic's Guide and share it with your friends. We really appreciate all your comments and questions and we're going to get back to the mailbag soon. So send us your questions and let us know what you like and don't like so that we can improve our show. Thank you and have a great day.