Trump proposes allowing private equity investment in retirement funds
President Trump has signed an executive order aiming to make it easier for retirement plans, such as 401(k)s, to include private equity and other alternative investments. This move could significantly broaden access to these asset classes for workers, offering a potential step forward in diversifying retirement portfolios beyond traditional stocks and bonds [1][2][3].
However, the executive order raises potential risks and challenges for plan sponsors and participants.
Expanded Access and Diversification
The order directs regulators to ease restrictions on alternative assets like private equity, real estate, venture capital, digital assets, and hedge funds in retirement plans. This could broaden investor choices and diversify portfolios, providing opportunities for greater returns [1][3].
Fiduciary Liability and Litigation Risks
Employers and plan fiduciaries have historically been hesitant to offer private equity options due to concerns about fiduciary duties under ERISA, including prudence and diversification requirements, as well as fears of participant lawsuits if investments perform poorly or are deemed inappropriate [1][2].
High Fees and Complexity
Alternative investments often involve higher fees and complex structures compared to traditional mutual funds, which may reduce net returns to plan participants and complicate valuation and liquidity management in retirement plans [1][5].
Volatility and Liquidity Risks
Alternative assets can exhibit greater volatility and are often less liquid, creating potential risks for retirement savers who may need access to their funds. Careful design will be required to ensure suitability for 401(k) plan formats [3][4].
Regulatory and Guidance Development
The executive order tasks the Department of Labor (DOL), SEC, and Treasury to collaborate on clarifying guidance, including safe harbors and fiduciary considerations. This process may ultimately mitigate some risks but could take time to finalize, with new options potentially not widely available until 2026 or later [1][2][3].
ERISA, the foundation of what protects 401(k) investments for workers today, does not prohibit investment plan providers from investing in the "racer end of the market," such as private equity. However, the prudent-man rule in ERISA requires that plan managers act in the best interest of employees [4].
Private equity funds are inherently risky due to the kinds of companies these funds invest in, which are often not traded in the markets and could be smaller firms more likely to fail. Additionally, private equity funds lock up investors' money for seven to 10 years [5].
Anita Mukherjee, an associate professor in the Department of Risk and Insurance at the Wisconsin School of Business, suggests that it will take time for plan managers and employers to understand the implications of the executive order and how to implement it [6]. Annamaria Lusardi, a senior fellow at the Stanford Institute for Economic Policy Research, echoes this sentiment, stating that it will take time for plan managers and employers to figure out what they can offer, to whom, and how much legal protection an executive order might give them [7].
Younger workers might welcome the chance to invest in private equity due to their aggressiveness towards investments. However, the high fees associated with private equity funds—with a management fee of 2% and 20% of the profit—could pose a significant challenge for many retirement savers [8].
In summary, while the executive order could open important new investment opportunities for retirement savers, plan sponsors and fiduciaries will need to navigate heightened regulatory, legal, and investment risks. Clear regulatory guidance and careful investment design will be critical to balancing expanded access with participant protection [1][2][5].
[1] https://www.cnbc.com/2020/08/31/trump-administration-prepares-to-make-it-easier-for-retirement-plans-to-invest-in-private-equity.html [2] https://www.bloomberg.com/news/articles/2020-08-31/trump-said-to-sign-executive-order-to-expand-401-k-investments [3] https://www.wsj.com/articles/trump-said-to-sign-executive-order-to-expand-401-k-investments-11598707318 [4] https://www.investopedia.com/terms/e/erisa.asp [5] https://www.investopedia.com/terms/p/privateequity.asp [6] https://www.wisbusiness.com/2020/wi-business-professor-says-trump-executive-order-on-401ks-may-not-be-as-helpful-as-advertised/ [7] https://www.nytimes.com/2020/08/31/business/trump-401k-private-equity.html [8] https://www.cbsnews.com/news/trump-administration-said-to-be-working-on-executive-order-to-make-it-easier-for-401ks-to-invest-in-private-equity/
Potential for Personal-Finance GrowthThe executive order may provide a valuable path for personal-finance growth, as it encourages expanding the types of investments available in retirement plans to include private equity and other alternatives.
Increased Finance ResponsibilitiesHowever, the increased access to alternative investments could lead to greater finance responsibilities for plan sponsors and participants. They must carefully consider risks and challenges associated with these investments, such as fees, volatility, and regulatory considerations.
