Will Private Equity and Private Debt funds break my 401(k)?

Everyone’s asking us about private equity and their 401(k) since the President signed an executive order in August allowing alternative investments to be available in employer retirement plans.

What is it?

Private equity and private debt funds have historically only been available to accredited investors who are in a financial position to take higher risks for the promise of higher returns. These funds are typically purchasing a portfolio of companies, real estate, or debts, holding those investments for years, then selling them and returning proceeds to investors.

What makes it problematic?

Private funds have some cons: 

  • They’re illiquid: you can usually only sell specific amounts on a specific schedule, if at all.
  • They’re expensive: the funds are typically performance-based, meaning the fund managers are taking large portions of gains, often with a minimum amount regardless of gain or loss.
  • They’re opaque: they’re often reporting performance using an “internal rate of return” metric, which is easily manipulated or “smoothed” to give the appearance of consistent, high returns.

Yale University’s endowment was one of the early adopters of this type of investing and it served them very well, until more recently. They are now making a widely-publicized exit from this type of investment.

If you’re interested in a deep dive into some of the challenges and you’re ok reading academic papers, Ben Bates wrote a good one recently. One finding: median returns are lower than public market returns over the past 4-5 years.

What does it mean to me?

Probably not much, if anything.

First, the sponsor of your plan has a fiduciary responsibility regarding the investments in the plan. So many sponsors may elect to exclude these funds.

We do think there’s something to monitor over the next few years: if you’re using target date funds, are those funds making investments into private funds as part of their holdings. 

What does Xena think?

Our investing philosophy continues to be centered around globally diversified, low cost, transparent index investing.

Why I answer “Never Better”.

If I asked you how you were doing, would your first response be, “Never Better”?

Now here’s the puzzler: should it be?

I started saying it over twenty years ago; doing so has been a grand experiment.

What does it even mean?

It means I’ve never been better than I am at the moment you asked me. Simple.

At least that’s what it means when I say it.

There’s also a sarcastic variant, used when it’s quite obvious that things are unwell. I avoid the sarcastic variant.

What (who) got me started?

I used to work for a guy named Pete. Every time I greeted Pete with a “How’s your day?” type of phrase, Pete responded, “Never Better.”

After about a month of these exchanges, my younger, more cynical self challenged Pete, “You’re full of it, how can that be continuously true?”

Rather than answer outright or explain it, Pete suggested I simply try a small experiment: give that answer for 1-2 weeks, then come back and let’s talk about it.

What I found in those first two weeks

I said it for about two weeks and at first I felt like a fool. The phrase felt unnatural, not mine, not practiced. I also felt a bit of an imposter: was I really Never Better? Really?

I began to notice responses from others across a range. At the positive end of the range, someone might say, “I love that!” or, “That’s fantastic!” On the negative end of the range, I’d get a sneering eye roll. Occasionally there’s silence, nothing (I had this response today). And all points in between.

Wow, this is interesting. This simple phrase immediately evokes a response, a window into how someone’s feeling in their moment. People are so unused to hearing the phrase genuinely presented that it almost always triggers a response of some kind.

Then I noticed something else in my own response, an unavoidable optimism. It becomes hard to say, “Never Better” without meaning it. Even when not feeling it, the phrase can be restorative in the moment. If already in a good mood, it can strengthen that feeling. It’s a “feedback loop”, a loop that occurs when a change in something ultimately comes back to cause a further change in the same thing. If the further change is in the same direction it’s a positive or reinforcing loop.

That small experiment led to a habit that’s with me to this day

Obviously I never stopped. “Never Better” comes out of me every day, easily and without hesitation. Two words both convey and reveal a lot in topical conversation.

If that interests you, then I encourage you to take Pete’s challenge: give the answer for 1-2 weeks, then come back and let’s talk about it.