Bloomberg Businessweek - USA (2020-06-29)

◼ FINANCE Bloomberg Businessweek June 29, 2020

25

ILLUSTRATION

BY

STELLA

MURPHY

● Thecompoundgainsofequitiesarealsocompounding racial

andeconomicinequality

The Americans

Left Out of the Boom

Overthe pastfewweeks,as crowdsmarched

throughthestreetsofAmericatodemandanend

tosystemicracism,thecountry’sstockinvestors

werebusybiddingupthemarketata dizzyingclip.

Althoughtherallyhascooleda bit,stockvaluations

remainhigh,andthequestionslinger.Doinvestors

notcareaboutwhat’sgoingoninthestreets?Do

theythinknoneofthiswilleveraffectthem?

Nexttoanyanswertothatquestionis a harsh

truth: Stock investing, with the power of

exposure to risky assets as investors reach their

retirement date. Such funds are often the default

investment option in their plan and are chosen

by plan sponsors who are obliged to look out for

employees’ interest. But this may mean that sav-

ers will have to read the fine print to know whether

some of their money is in a private equity fund.

The complexity and illiquidity of PE funds may

be a roadblock for some employers. “It is like a

square peg in a round hole,” says James Veneruso,

who advises on retirement plans at consulting firm

Callan. But that doesn’t mean such challenges can’t

be overcome if funds can make some changes,

including lower fees, he says.

A group of unions and consumer and investor

advocacy organizations, including the Consumer

Federation of America and Public Citizen, sent a

letter to Secretary of Labor Eugene Scalia urging

him to pull the guidance because of “gaping holes

in investor protections.” The organizations ques-

tioned not only whether small-time savers have the

sophistication to make decisions on the asset class,

but also whether employers and others who are in

charge of choosing plan options do.

Proponents of private equity argue that PE funds,

which have long been used in traditional pension

plans, have outperformed public stocks. The indus-

try also cites private equity’s diversification benefits,

as well as the opportunities in the private markets as

the universe of public companies shrinks.

Not everyone agrees that private equity offers

such impressive returns, especially after the man-

gers’ fees. A recent paper by Ludovic Phalippou,

a professor of financial economics at University

of Oxford’s business school, found that private

equity has performed in line with comparable pub-

lic stocks. Large private equity managers have dis-

puted his findings.

One issue is that it’s difficult to agree on the right

benchmark for PE investments—should they be com-

pared to the S&P 500 index or small companies or

global equities? And the way their performance is

commonly cited, as an internal rate of return, can be

confusing and hard to compare to returns reported

by mutual funds. IRR factors in the speed at which

private equity hands back capital to investors after

it’s put to work. “The problem is these numbers are

not what you think they are,” says Phalippou. “These

are not rates of returns that somebody earned on

their capital year after year,” he says.

Lurking behind all this is a broader policy fight.

Regulators in the Trump era have argued that retail

investors should have broader access to a lot of

investments previously limited to wealthy individ-

uals and institutions. Democrats have generally

sought more regulation of financial products, and

some have been critical of private equity, blaming it

for loading up companies with debt and causing lay-

offs and bankruptcies. The government’s approach

could soon change with the presidential election

less than five months away. As a harbinger, six

Democratic senators and Bernie Sanders, the

independent from Vermont, sent a letter to Scalia

urging him to reconsider his decision. �Ben Bain

andSabrinaWillmer

THE BOTTOM LINE If private equity gets into 401(k)s, it may

be layered inside other funds, making it less risky but potentially

harder for savers to spot.