Conman-in-chief takes aim at America’s retirement savings with PE and crypto
(Originally published Aug. 11 in “What in the World“) Trump may have found another way to pull the rug out from under the stock market.
Trump just signed an executive order allowing 401(k) retirement plans to offer private equity funds and cryptocurrencies. This is in many ways good news, in that it gives Joe Public access to asset classes that have traditionally been reserved for the über-rich.
But his decision has stirred a hornet’s nest of controversy about the potential risks he’s exposing ordinary savers to. Private equity firms invest in companies not listed on public stock exchanges. Instead, they invest through specialized funds raised from large institutions like pension funds and endowments and, increasingly in recent years, directly from wealthy individuals.
Why would companies take money from them? Often, it’s because the companies aren’t yet large enough or healthy enough to go public, and PE firms are willing to give them capital more cheaply than, say, a bank, in return for a greater say in how the company is run. In return, the PE firm gets a controlling stake, ideally at a lower valuation than public markets would get and can then help boost the company’s value before selling it at a higher valuation—and obviously a higher price—to public investors later. So, there’s a form of private equity called venture capital that invests in start-ups. And there’s a kind of private equity that specializes in investing in troubled companies that need to be turned around.
Not so long ago, anyone with serious cash was clamoring to invest in private equity. And for good reason. Over the long run, PE has outperformed the stock market. From 2000 to 2020, the U.S. Private Equity Index had an average annual return of 10.48%, compared with just 5.9% for the S&P500.
But that outperformance has been slipping. From 2010 to 2020, private equity averaged 13.8% a year, while the S&P500 returned 14%. In the five years up to March 31, private equity returned just 18.3%, while the S&P500 has more than doubled. The pandemic and the ensuing recession hit private equity hard: fundraising slowed, and deal-making stalled. Worse, some PE firms had tried to bolster their returns by leveraging the cash they raised with debt. At one point debt accounted for 70% of PE investments. And with higher leverage came higher valuations, particularly for tech startups. Investors happily accepted these increasingly astronomical valuations, as did company founders, despite concerns they could never produce the kind of profits to justify them. As valuations spiraled upwards, some company founders and shareholders found that they preferred PE to going public. No pesky quarterly reports to prepare; no aggravating shareholder meetings to attend. Not only were companies choosing not to list, but some were even going private.
When the Fed started raising interest rates again in 2022, therefore, many of these firms struggled. Slower returns cooled investor enthusiasm for PE. Fundraising in the first half of this year sank to the lowest level since the pandemic. Faced with shrinking capital to pay their 2% fees and weaker returns for their 20% commissions, PE firms have been aggressively lobbying for access to the vast $12 trillion pool of 401(k) assets.
That’s where the picture gets murkier. The opacity extends to PE investors, too, though. Unlike public stocks, which are traded daily with transparent prices and regulated disclosures, PE funds operate on infrequent valuation cycles, complex fee structures, and limited liquidity. That makes it hard for PE investors to know what their holdings are worth at any given moment. And PE’s “2 and 20” structure eclipses the typical 0.2%-0.3% fees charged by the mutual funds now on the 401(k) menu.
Critics of Trump’s move warn that introducing these assets into retirement plans could expose everyday savers—many of whom do not actively manage their portfolios—to risks they may not fully understand. Worse for those looking to liquidate their 401(k) and retire, they can’t just sell their PE investments quickly if they need cash.
And that leaves aside, for now at least, the issue of cryptocurrency’s inclusion alongside private equity in Trump’s order. While Trump is a big fan, this newsletter is not, considering their negligible value as stores of value, their primary function as a means of exchange between criminals, and their popularity as a Ponzi scheme perpetrated by their founders.
Whatever the complexities and uncertainties of investing in PE and crypto-crap, including them in 401(k) options is bound to unleash a certain amount of FOMO among investors. The more savers plow money into these funds, the more may feel pressured to follow suit.
Worse, this herd mentality could accelerate the flow of funds away from public stocks, much the same way that PE siphoned funds out of public markets in its heyday. Opening the door to private equity and cryptocurrencies could trigger a sizeable transfer of capital out of public markets. Investors needing to diversify or capitalize on these new options may sell shares, putting downward pressure on stock prices.
Importantly, this shift wouldn’t reflect fundamental changes in outlook for listed companies. It would be a simple reallocation driven by Trump’s edict.
On the flip side, greater access to private equity might democratize a segment of investing previously closed to all but the wealthiest. If the savvier 401(k) investors navigate the PE’s inherent risks, fees, and illiquidity to reap higher returns? Fantastic!
And while interest rates are likely to ease, they’ll do so only because the economy is slowing thanks to Trump’s other hairbrained policies—tariffs foremost. Given the motivation behind the PE industries push for access to 401(k)s, this looks less like a way to level the investment playing field than yet another way for Trump and his Gilded Age plutocrats to suck more cash away from America’s bourgeoisie.