Bitcoin, Private Equity, and Other Alt Investments Are Coming for Your 401(k). What Could Go Wrong?

(Dreamstime)

The Trump administration has opened the door for alternative assets in retirement plans, but investors should proceed with caution.

On Thursday, President Donald Trump signed an executive order allowing investors access to alternative assets like private equity and cryptocurrency in their 401(k) and equivalent plans. The order directs the U.S. Department of Labor to re-examine the agency’s guidance on the responsibilities that plans have to their participants with respect to alternative assets, according to a White House official.

This deregulatory push paves the way for alternative asset managers to tap the more than $12 trillion in Americans’ 401(k)s and equivalent plans. Private-equity managers in particular have been eyeing that pot since fund-raising has slowed among endowments and other traditional customers. Firms such as Goldman Sachs and Voya Financial have been readying private market offerings for the 401(k) market.

The pitch is that nonpublic securities offer investors the potential for higher returns that are less correlated with stocks and bonds. Private equity and credit have traditionally been the purview of the wealthy, and including them in retirement plans would democratize access, proponents say. A White House official said allowing alternative assets in retirement plans would provide for “better returns and diversification.”

Opponents counter that generally neither 401(k) plans nor participants have clamored for such offerings, which they say are driven by supply rather than demand. It remains to be seen whether the returns will justify what is sure to be higher fees than stock, bond, or simple target-date funds.

Since the early 2000s, pension funds have increasingly added private assets to their investments. Pensions differ from 401(k) plans in that they offer a defined, guaranteed benefit to participants regardless of market returns, whereas 401(k) plans depend on contributions from workers, whose individual balance fluctuates with market returns.

Private assets didn’t measurably improve pensions’ returns, says JP Aubry, associate director of research at the Center for Retirement Research at Boston College, who conducted a study on them. Before the financial crisis of 2008-09, they outperformed broad market, passive strategies slightly, while they underperformed after. “On the whole, it’s been a wash,” Aubry says.

Such mediocre performance may not justify the increased risks that come with alternative assets, which include higher fees, lower transparency and liquidity, and—in the case of cryptocurrencies in particular—high volatility. What’s more, if private asset managers gain access to the vast 401(k) market, there might not be enough good deals for all that capital, says Anthony Kure, senior portfolio manager at Johnson Investment Counsel in Cleveland, which could lead managers to pursue deals that aren’t so advantageous.

It’s unlikely that workers will see new offerings in their 401(k) plans overnight, experts say. Companies sponsoring plans are conservative and worry about getting sued for offering inappropriate investments to their workers. That concern isn’t going to go away with Thursday’s executive order.

Private assets might have a certain cachet, but public markets work just fine, says Jason Kephart, senior principal, multi-asset manager research at Morningstar. “People who have invested in public markets over the last 15 years have done well.”

Write to Elizabeth O’Brien at elizabeth.obrien@barrons.com