Your 401(k) is almost certainly chock-full of meat-and-potatoes investments like stocks and bonds. An executive order from President Donald Trump last week might introduce some new dishes to the menu.
Trump’s move will open up alternative assets like private equity and cryptocurrency to retirement funds, a potential feast for the industries involved. But there’s no guarantee retirement fund administrators will rush to add those alternative assets to what they’re serving.
Freshmen Asset Class
Trump’s order instructs the Labor Department and other regulators to redefine what is considered a qualified asset in 401(k) retirement rules, allowing plans to invest in higher-risk alternative assets like PE, cryptocurrencies and real estate. Current federal rules deter most defined-contribution plans from investing in alternative assets, which is why they tend to prefer stocks and bonds. Any formal changes are probably still months away and, before assuming they usher in a sea change in investment strategy, it’s essential to look at one key piece of legislation.
The Employee Retirement Income Security Act, the law that governs pension plans, isn’t going anywhere. This is especially important because the law requires 401(k) plan administrators to act solely in the best interests of beneficiaries, which often translates to a sound investment strategy. The plans will no doubt think twice before rushing into private equity and crypto investments:
As a relatively new asset class, cryptocurrency has exhibited significant volatility. For example, while Bitcoin has risen over time, it has experienced over eight corrections of more than 50% in its 17-year existence. Other digital assets have proven even more volatile.
Private equity firms, meanwhile, typically charge relatively high management and performance fees and place restrictions on redemptions, which can eat into net returns. Longer investment horizons, which make private equity funds less liquid, may also conflict with some 401(k) administrators’ strategies. Finally, the sector has underperformed public markets for three of the past four years, reversing the common wisdom of the previous decade that they offered higher returns.
A Helping Hand: Crypto firms have been inundated with cash and interest from traditional Wall Street players this year. Access to 401(k)s, in whatever amount materializes, would be something of a cherry on top of the sundae at crypto’s coming-out party. The private equity sector, on the other hand, could really use the help. Private equity backers, which traditionally include pensions, university endowments, family offices, private foundations and sovereign wealth funds, have increasingly lowered or declined new commitments, with growing numbers opting to cash out from certain investments. Professionally managed 401(k) funds, which roughly 90 million Americans use, would open up a $9 trillion market to the sector, which could use financing beyond its traditional LPs, who have signaled they’re tapped out.