Editorial: Managers of exotic investments want more access to your 401(k). Bad idea.

Chicago Tribune

5 days ago

After George W. Bush won reelection in 2004, he famously decided to spend his political capital on an all-out effort to overhaul Social Security and oblige ordinary Americans to make investment decisions on a portion of their federally funded retirement income.
The initiative was a high priority for Wall Street, which salivated at the opportunity to manage this massive pool of cash and earn fees on all those assets. Democrats successfully depicted Bush's Social Security reform as a threat to Americans' economic security in their golden years, and Bush's top priority fizzled without even a congressional vote. Arguably, his second term never really recovered from that failure.
Two decades later, Social Security remains at risk of insolvency and will require reform of some sort, quite likely by the end of this decade. But right now we wish to address yet another Wall Street gambit to get access to more of ordinary Americans' retirement nest eggs.
President Donald Trump is preparing an executive order aimed at clearing the way for employer-sponsored 401(k) plans to offer private-equity and private-credit funds as investment options, The Wall Street Journal reported. Those illiquid asset classes now are available mainly to institutional investors like endowments and pension plans, as well as high-net-worth individuals.
We're concerned the net result of this maneuvering is that ordinary investors will be taking considerably more risk in their 401(k)s without even being aware of it.
Private-equity firms and non-bank lenders have grown impressively over the last few decades due to substantial demand for their offerings from those sophisticated investors. But these big-time financial players — think Blackstone and Apollo Global Management — have begun to saturate their existing markets. That's where your 401(k) plan comes in. There was $12.4 trillion stashed in U.S. defined-contribution accounts at the end of last year. Managers of more exotic investments than index funds want a bigger piece of that pie.
There's good reason these highly illiquid, opaque asset classes have been confined until now to institutional investors. They're riskier than stocks and bonds — the assets that dominate 401(k) plans today — and they're harder to value, providing opportunities for their managers to obscure how well (or poorly) they're doing.
Such funds also are difficult to exit for their investors, who typically must remain for the duration of each fund (typically 10 years or longer). Many such funds have performed very well, which is why their participants keep investing in these firms' new offerings. But they're not for everyone, and their investors must carefully weigh the risks before taking the plunge.
Making the timing of this move even worse, JPMorgan Chase CEO Jamie Dimon, the nation's most high-profile banker, is warning that private credit funds may be heading for a 2008-style crisis. There seems to be too much money chasing too few deals, and that dynamic usually leads to reckless lending.
Direct lending has ballooned in the past two decades, reaching nearly $700 billion last year, according to The Wall Street Journal. Per that model, non-bank lenders strike deals with corporations and buyout firms that rely on debt for their acquisitions. The borrowers that turn to direct lenders in lieu of traditional banks typically do so because the non-bank lenders provide more flexible terms, albeit at higher interest rates.
There's a reason banks don't allow for as much flexibility in their loan covenants. When borrowers can't cover their debt payments or show other signs of financial strain, more flexible terms buy them time and often lead to them taking on even more debt to meet their cash needs. That can make the ultimate losses for the original lenders that much deeper at the point of bankruptcy.
All that said, it's one thing to make these alternative funds available to those 401(k) participants who prefer to weigh their own risk tolerances and pick and choose among their options in determining their retirement-fund portfolio. It's another to stick these asset classes into so-called target-date funds that are designed to be cookie-cutter investment options for those plan participants who want a ready-made solution.
And winning coveted places in those cookie-cutter portfolios increasingly is what these private-equity and private-credit firms are seeking. Some of the nation's largest administrators of 401(k) plans, like Boston-based State Street, have taken initial steps in that direction. Down that path lies many potential unhappy surprises in our opinion. And, with the Trump administration apparently enthusiastically on board, the federal government appears intent on giving the investment industry legal protections from those future aggrieved customers.
Who will tap the brakes on this incautious course?
With private-sector pensions essentially relegated to history, the 401(k) plan is the primary vehicle financing retirement for most Americans. Unlike pensions, these plans aren't guaranteed to provide retirees an income until the end of their days.
Injecting 401(k)s with risks that heretofore were shouldered by our most sophisticated investors doesn't seem aimed mainly at ensuring more Americans have enough socked away to retire with dignity. It looks designed rather to further enrich those who already have reached the mountain top.