The Case Against PE in 401(k)s

Obviously, not everyone is a fan of the PE in 401(k)s plan. Some investor advocates, including Benjamin Schiffrin, director of securities policy at Better Markets, a nonprofit seeking to promote the public interest in financial markets, say the potential for harm trumps potential benefits.

In early June, Schiffrin issued a fact sheet, titled, “Private Market Assets Do Not Belong in 401(k)s,” along with a statement voicing his concerns.

“There is no reason to endanger the retirement savings of millions of ordinary American investors by exposing their 401(k)s to expensive and risky private market assets,” Schiffrin wrote. Noting that private market firms say that they should be able to access 401(k)s so retail investors don’t miss out on their “supposedly high” returns, he said the fact sheet shows the benefits of the private markets are overblown. “Research increasingly shows that private market assets do no better than a portfolio comprised of public market stocks and bonds and in many cases do worse.”

“The question shouldn’t be what is good for the private funds industry. The question should be what is good for investors and their 401(k)s, and the answer is not private market assets.”

Benjamin Schiffrin, Better Markets

He says the push for PE in 401(k)s is not coming from participants or plan sponsors (who he says are fearful of violating their fiduciary duty to act in the best interest of participants), but from private market firms who are finding it harder now to raise money. “Their traditional sources of funding—institutional investors such as pensions and endowments—have evaporated,” Schiffrin wrote.

“It’s not surprising that the industry looks at retail investors and sees dollar signs, but the fact that the industry covets access to millions of Americans’ 401(k)s is no reason to expose the retirement savings of those Americans to the expense and risk of the private markets,” he added. “The question shouldn’t be what is good for the private funds industry. The question should be what is good for investors and their 401(k)s, and the answer is not private market assets.”

While private equity can offer high returns, a recent study from the Johns Hopkins Carey Business School suggests that these riskier investment vehicles may not align with the financial security and predictability that most 401(k) participants expect.

Among the reasons listed in the study:

• Private equity funds lack transparency. Unlike publicly traded companies, which must regularly report financial performance, PE-backed firms operate with less transparency. This makes it harder for investors and financial advisors to assess risk, making these funds less predictable compared to traditional stocks and bonds.

• Long investment timelines limit liquidity. Private equity investments typically take more than a decade to generate returns, which can be problematic for 401(k) participants who need access to their savings when they retire. Unlike stocks, which can be bought and sold easily, PE funds often require investors to wait years before they see meaningful returns—if any.

• Higher fees reduce net returns. Private equity funds charge higher management and performance fees than traditional public market funds. While some PE investments deliver strong returns, many studies suggest that once fees are accounted for, these investments may underperform compared to publicly traded companies.

High fees and underperforming funds attract the attention of ERISA attorneys. Under ERISA, employers have a fiduciary duty to ensure that investment options in their 401(k) are prudent and have reasonable fees.

“Adding alternative investments must be done in a way that fulfills ERISA fiduciary responsibilities and protects participants who may not understand how these complicated investments work from losses due to uninformed decisions,” wrote Cohen & Buckmann co-founder and partner Carol Buckmann in a recent blog post.

“ERISA imposes several restrictions on fiduciaries looking to add alternative investments to their plans. First, they must satisfy the fiduciary duties of prudence, loyalty and diversification when selecting alternative investments, including making sure that the fees are reasonable in relation to the services provided,” Buckmann continued. “Fiduciaries must also avoid non-exempt prohibited transactions, consider plan liquidity requirements, and deal with hard-to-value assets and custody issues.”

Ary Rosenbaum of The Rosenbaum Law Firm, P.C. addressed the Empower initiative in a June 16 post on JD Supra, offering words of caution.

“I’m not saying private investments should be off-limits forever. But throwing them into DC plans without a clear roadmap for transparency, education, and fiduciary oversight is reckless,” Rosenbaum said. “Empower is calling this a ‘landmark initiative.’ I call it a potential minefield.”

He closed by warning plan sponsors and advisors to proceed with extreme caution. 

“Ask the hard questions. Demand clear answers. Don’t get swept up in the hype,” Rosenbaum said. “Because in the retirement plan world, there’s a fine line between opportunity and overreach—and crossing it could cost your participants dearly.”

Editor’s Note: Read the full cover story as it appears in the magazine (with additional sidebars) at this link.

SEE ALSO:

• Private Markets Gain Ground in DC Plans; But Education, Legal Clarity Remain Hurdles