Private equity firms are increasingly interested in offering their investment options within 401(k) retirement plans. However, this shift raises concerns about the suitability of these complex, illiquid assets for individual investors. Most 401(k) plans currently do not include private equity investments, which involve companies that are not publicly traded.
Large pension plans and university endowments have historically invested in private equity due to their long-term investment horizons, but 401(k) participants have generally not had access to these options. As of November 2024, only 2.4% of 401(k) sponsors had added private equity to their plans, according to the Plan Sponsor Council of America. Employers may be hesitant to include these options due to the potential for lawsuits, as private equity investments often have higher fees than public company investment funds.
Under the Employment Retirement Security Act (ERISA), employers have a fiduciary duty to ensure that 401(k) investment options are prudent and have reasonable fees. Private equity investments are often riskier and less transparent than public investments, making it difficult for investors to monitor fund performance regularly. These investments are also considered illiquid, meaning investors cannot easily withdraw their money when needed, such as during job changes or losses.
Despite these concerns, there is a growing push to provide retail investors and retirement plan participants with more access to private capital investments. Regulatory changes could make it easier to include alternative investments like private equity, private real estate, and hedge funds in 401(k) and IRA accounts.
Private equity in 401(k) plans
Proponents argue that as more companies remain private, investors may need exposure to both public and private companies to achieve a well-diversified portfolio. However, the lack of a centralized way to track private capital fund performance can make it challenging for average investors to evaluate these opportunities. Critics, such as Benjamin Schiffrin, director of securities policy at Better Markets, argue that exposing employee and retiree nest eggs to private capital could be detrimental.
Schiffrin believes that the push to open private markets to 401(k)s is driven by private market firms struggling to raise capital from traditional sources, such as pensions and endowments. For plan sponsors, including private equity options would necessitate extensive due diligence regarding the underlying investments and their associated fee structures. Jerry Schlichter, a lawyer known for pioneering lawsuits against excessive 401(k) fees, warns that this could put companies at risk of breaching their fiduciary duty.
Moody’s has also cautioned that the accelerated push to grant private capital firms access to the multitrillion-dollar retirement investment industry carries risk, highlighting the potential for a liquidity crisis, as retail investors typically expect ready access to their cash, which may not be feasible with private investments. While private equity has the potential for strong returns over time, the results have been mixed. Investors may pay more and have less transparency without a guarantee of better returns.
Jason Kephart of Morningstar notes that external factors, such as economic downturns and geopolitical concerns, will impact private companies just as they do public ones. In conclusion, while public stocks and bonds have historically performed well for long-term investors, the question of whether private equity should be included in 401(k) plans remains complex. Careful consideration of fees, risks, and the ability to achieve diversification is essential before making any decisions.