654. Is the Public Ready for Private Equity?

Key Takeaways

A Trump executive order aims to expand retail investor access to private markets, including crypto and private equity, for 401(k) plans.
Private equity has historically outperformed public markets but shows recent signs of diminished returns and market maturity.
Experts warn retail investors about high fees, illiquidity, and potential 'second-tier' access to private market investments.
Concerns include increased litigation risks for 401(k) managers and potential negative impacts on public market liquidity and company listings.
The move towards less regulated private markets may expose retail investors to greater financial risk and reduced transparency.

On August 7th, President Trump signed an executive order, 'Democratizing Access to Alternative Assets for 401k Investors.'
The order targets including assets like crypto, real estate, private credit, and private equity in retirement investment options.
Blackstone launched an advertising campaign called 'Eureka,' comparing the opportunity to the 1849 California gold rush, seeking retail customers as institutional appeal potentially wanes.

Professor Steve Kaplan's research on 1980s leveraged buyouts showed companies taken private with significant debt generally improved operating performance.
Private equity, defined as equity not publicly traded, now typically uses less leverage, around 50-60%.
The number of physician practices owned by private equity has increased approximately 700% since 2012, illustrating its expansion into diverse sectors.

For 25 years prior to 2020, private equity funds consistently beat the S&P 500 net of fees.
Funds from 2020-2022 have lagged due to pandemic-era volatility, low interest rates, and subsequent inflation and rising rates.
Increased interest rates and high deal prices from 2021-2022 are making assets harder to sell, leading to a backlog of unsold investments and decreased new fund commitments.

Professor Elisabeth DeFontenay expresses skepticism about private equity's continued outperformance, noting the overall market has matured.
She suggests increased capital has led to higher valuations and lower returns, causing private equity returns to converge with public markets.
Host Stephen Dubner introduces the idea that a new executive order might offer retail investors participation in a 'winding-down party.'

Professor DeFontenay highlights private equity's high '2 and 20' fees (2% annual management, 20% profit share) compared to low-cost index funds.
She notes retail investors may not get access to the same quality investments as institutional investors, potentially receiving a 'second-tier' choice.
Economist Steve Kaplan cites concerns about potential depressed returns due to too much capital inflow and less favorable fund access for retail investors.

The Trump executive order directs the SEC and Department of Labor to facilitate retail investor access to private markets, including cryptocurrency, for 401(k) plans.
Professor DeFontenay argues the order may increase litigation risk for plan managers by implying a duty to offer private assets, even if less advantageous.
Cryptocurrency markets are described as opaque, illiquid, and pose significant risks for retail investors who may not understand underlying assets or costs.

Professor Elisabeth de Fontenay acknowledges her cautionary message about retail investors entering private markets is unlikely to influence the current era of market exuberance.
She notes that while private equity firms may benefit from increased retail investment, her warnings about potential poor outcomes for investors are not being widely heeded.
Americans hold approximately $13 trillion in retirement savings, with an estimated 10% potentially flowing into private equity funds, which DeFontenay predicts would be detrimental for retail investors.

The increasing involvement of retail investors in private equity raises questions about transparency, as private companies are not subject to public disclosure requirements.
Avoiding public disclosure offers increased discretion and speed for private equity, contrasting with public companies, which are slower but less prone to fraud.
The current financial landscape, with increased investment in private firms, may disproportionately benefit the wealthy, raising concerns about its broader economic impact.

There is concern that retail investors, historically making poor investment choices in high-fee products, will be steered into less liquid and potentially risky private market investments.
A significant outflow of retail money into private markets could negatively impact public stock markets, leading to fewer companies going public and a concentration around a few large firms.
This shift risks diminishing the U.S. financial ecosystem's global standing and inviting more scrutiny and litigation, potentially altering private equity's performance.