Private Markets in Retirement Accounts: A Skeptical Analysis

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We delve into the controversial topic of allowing private equity, real estate, debt, and even cryptocurrency into 401k retirement accounts, offering a skeptical analysis of this potential shift in retirement planning.

• Government is willing to allow private markets and crypto in 401ks, though these options aren't widely available yet
• Private markets involve less transparency and liquidity than traditional investments
• Historically, private investments required accredited investor status, assuming wealth equals financial education
• Many wealthy individuals have fallen victim to investment scams like Bernie Madoff and FTX
• Employers may face significant liability if employees lose money in private market 401k investments
• Marketing tactics of private equity firms often create false exclusivity around their products
• Volatility measurements for private investments are misleading due to infrequent pricing
• Traditional portfolio optimization models may overweight private investments due to understated volatility
• Gating provisions in private investments could restrict access to retirement funds
• Education and proper sizing of allocations would be crucial if these investments become mainstream options
• Current recommendation is caution before jumping into private markets in retirement accounts

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Episode Transcript

Steve Davenport (00:02):
Hello everyone and welcome to Skeptic's Guide
to Investing.
Today I'm here with Clem Millerand we don't have a guest.
We've decided that it's time toget back to talking about
markets and giving our skepticalviews on things.
So today's topic, the 401k.
Is it a place for privateequity, private real estate,

(00:24):
private debt?
How do we feel aboutalternatives in our 401ks?
And I think I'm going to askGlenn, because he loves markets
and he loves equities and heloves the rest.
So, Clem, are you going to bebuying private real estate,
private equity or private debtin your 401k?

Clem Miller (00:47):
So you know the thing well right now you just
can't, okay, buy those things in401ks this is a hypothetical
question, but the government hassaid that they are willing to
allow it and not just privatemarkets, but also crypto as well
in 401ks and of course, we allknow that crypto isn't really an

(01:11):
investment.
So that is just insane to putpeople's retirement assets in
crypto.
So let's turn to privatemarkets for a second private
markets.
The issue with private marketsis that there's less

(01:34):
transparency and there's lessliquidity when it comes to
private markets, and that's whyuh, historically, and that's why

(01:57):
, historically, you needed to bea qualified accredited investor
, which means basically rich orricher, to be able to….

Steve Davenport (02:01):
Well, I'm told that if you're in Boston, New
York or LA, having $2 million isnot rich.

Clem Miller (02:04):
Just remember that.
Okay, so neither of us is inBoston or New York.
We may have the money, butwe're not putting it in private
equity, right, but privatemarkets.
The rules have been that you'vegot to be, you've got to be

(02:27):
wealthy, and the presumption youknow super wealthy, high net,
high net worth, ultra high networth to do to do private equity
, to put it into your accounts.
And the presumption is that youknow if you have that kind of
money, then you're educatedenough to be able to make that
kind of decision.
And I don't know if I agreewith that, because there are a

(02:51):
lot of people out there who arevery wealthy who don't have a
clue as to what they're doing.
Think of all the people who putmoney with Bernie Madoff right,
who were fooled by him.
Ftx, yeah, ftx.
So there are a lot of wealthypeople out there who just don't

(03:13):
know what's going on.
So this presumption that beingwealthy is evidence of being
educated in investments is justnot accurate.
But in any case, don't you?

Steve Davenport (03:24):
I think the fiduciary nature of 401ks will
make it harder for some of thesponsors to put the I mean
ultimately-.
Well, yes, If you put it inthere as a sponsor and it
delivers horrible results foryour employees, is there a
liability at the company level?
Is there a liability at themanager level?

(03:45):
Is there liability at themanager?
So who's going to go after whogovernment is going to be
allowing these things to go into401k accounts, but it's
ultimately up to the employersthemselves to decide what should
go into those accounts.
So what do you think as options?

(04:11):
Let's just go to the end game here, which is
something goes down 50% getstaken out 4,000 people invested
over $20 billion.
They lost $10 million of it.
Who pays Clem?

Clem Miller (04:31):
So.
So ultimately, employeesthemselves are going to get hit
there's no question about thatand employers if there's a
problem with the private equity,private markets, crypto in

(04:52):
401ks, the employers are goingto get sued by employees.
There are plenty of law firmsout there that sue employers on
behalf of employees who've lostmoney in 401ks, and so they I
mean, I've seen some cases arevery simple and they didn't seem
like the company did a lotwrong.

(05:14):
Yeah, Still paid a lot of money,so I think I think that a lot
wrong.
Yeah, he still paid a lot ofmoney.
So I think I think that a lotof companies, will not allow
private markets and crypto asoptions in their 401ks a lot.
Now, that being said, there areemployers who have no idea what

(05:39):
they're doing, right?

Steve Davenport (05:42):
Well, I mean the industry.
There's two reasons whysomething happens, right that it
generally comes down to is thegovernment saying it's okay to
do this?
And are there companies who arein the private equity and
private real estate space thatthat that are doing things that

(06:05):
we should, we think are going todo them well and therefore we
need to let them come to market?

Clem Miller (06:12):
and and you know well, the private equity
companies I'm not going to namenames, but you know there are
companies out there that arereally good at marketing and
they market private markets in asense to try to say, well, you

(06:36):
know, to give it kind of apanache, right, oh, we're giving
you the opportunity to investalongside the, you know, the
uber wealthy, right, we'regiving you that opportunity to
do that.
I mean, that kind of statementalone should make you wonder,

(06:56):
like, why are they giving methis opportunity to begin with?
Right, it should make you think, right.
So, so my concern is thatyou're going to have the private
market investment companieswith big marketing budgets going
around selling these products,trying to create this image that

(07:24):
this is the way to invest, theway to invest in the future,
that they're going to cite thefact that the government's
allowing it not just asallowance but as endorsement.
Well, the government has toldus all that it's OK to do this.

(07:44):
The government wants us toinvest in this right.

Steve Davenport (07:48):
Well, also Clem .
I mean, as CFA's, we both gotto say the way that they
calculate their volatility,using quarterly numbers, versus
daily numbers, right iscompletely different right.
When they show you a volatility, the volatility is not actually
the volatility.
The volatility is dampenedbecause of the way they price it
right.

Clem Miller (08:07):
So there's no.
It's not logical to put, it'snot logical to look at sharp
ratio and other things forprivate equity.
It's not logical to try to putprivate equity into private
markets, into an optimizer right, because that optimizer is

(08:28):
going to look at the lowvolatility and it's going to
give you a very high weight toprivate markets because of the
lower volatility Right.

Steve Davenport (08:37):
And so I mean I look at this for investors and
say it's on the radar, it's inthe future.
If you look down the road, thisis a year, two year decision
that you don't have to make yet.
But in my mind we have to kindof be a little bit skeptical of
the fact that this got throughso quickly.

(08:58):
And there's these groups ofpeople, whether it's with Vance
or other parts of theadministration, that have been
in that space and think, oh,that's a great space for
everyone.
And I think in reality we knowthat everyone who has a 401k now
might not be the true audiencefor this, and we have to just be

(09:19):
smart about whether we thinkthese solutions are going to be
good for everyone.
I don't think they'renecessarily going to be bad for
everyone, but I think we're, wayyou know, we're in the early
innings here, and so I think inthe early innings I would just
say Caution is the better partof discretion here.

Clem Miller (09:45):
I would say at this point if you're presented with
that option of private equity,private markets in a 401k, I
would say wait, don't jump on itright away.
Away wait.

Steve Davenport (10:03):
I think it needs some time.
I think this idea sprung out ofyou know, trying to support
crypto and trying to help withstablecoin, trying to do a lot
of things at one time, and I'mnot sure you know.
For a while it was talkingabout whether you should expose
401ks to IPOs or other companies, and then they said no, we

(10:24):
should wait until the company isestablished in markets and part
of a benchmark before we startto make you know that type of
opportunity available.
And I would say here we'regoing way beyond an IPO, because
these are companies that arepre-IPO, these are companies
that have not establishedthemselves and have a higher

(10:45):
failure rate.
Therefore, yes, they have thosecases where they can win, but
it's most likely to be aportfolio of companies.
It's most likely to be offeredby very big firms who have very
big marketing budgets, but alsovery big lawyers who are going
to help them to develop and rollout a product that, in my mind,

(11:08):
could look so different thanthe standard product that it
might not be the same.

Clem Miller (11:14):
And, steve, you know some of these, some of
these private markets productshave gating in them right when
you know gating for those of youwho might not know what that is
you know the private marketsfirms can say, well, you know
that we're having a liquidityissue right now, so we're not

(11:36):
going to let you take out yourmoney, you know at on demand, or
you know we may allow it todribble out, you know once a
quarter or whatnot.
That kind of thing is just not,you know, is just not the kind
of thing you can put into aretirement account, in my
opinion.

Steve Davenport (11:54):
Well, I think you can put it there, but it has
to be sized properly.
It has to be understood.
But it has to be sized properly.
It has to be understood, it hasto be in conjunction with all
the other assets and so who'sgoing to make that decision?

Clem Miller (12:06):
Joe Smith.

Steve Davenport (12:08):
Correct.
It requires a lot more education, a lot more knowledge and a lot
more ability to understand therisk you're taking.
And if you have those things, itcould work.
But all I'm saying is it's aleap and I think before we leap

(12:30):
we should look and look at whatit is and look and understand it
better.
And I'm just saying let's havea degree of caution.
And I think the 401k has done agood job for a lot of people,
but is it the right place forprivate equity?
It might be, but it's going tobe a long time before the type
of vehicle, the type ofeducation and the type of plan

(12:51):
sponsor who supports it isreally organized in such a way
that everyone in the 401k isserviced the same, the higher up
executive to the factory worker.
That's why 401ks have to beunderstood completely by
everyone, because they're rolledout to the whole company, no

(13:15):
matter what their graduationlevel is or what their degrees
or certificates are, matter whattheir graduation level is or
what their degrees orcertificates are.
So I would just say caution isthe better part of valor.
Yeah, Do you have anything youwant to add before we wrap it up
?

Clem Miller (13:31):
Nope, I think we've covered that one.

Steve Davenport (13:33):
All right, everybody.
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