Trump’s DOL and SEC watchdogs say allowing 401ks to gamble on private equity investments for the first time ever will help workers “overcome the effects coronavirus has had on our economy.” 401k investors—don’t believe a word of it. More likely, private equity wolves are counting on 401k lambs to provide COVID relief to their struggling funds.
Last summer Trump’s Department of Labor opened the door for plan sponsors to add private equity funds to their 401(k) plans. Trump SEC Chairman Jay Clayton cheered from the sidelines. That’s a huge win for the private equity industry since 401ks hold nearly $9 trillion.
The explanation the DOL provided for its reckless action was mind-boggling.
Private equity gambling—ramping up the fees and risks to 401k savers—will help workers “overcome the effects the coronavirus had had on our economy.”
401k gambling as “COVID relief” for worker retirements?
One thing is for certain: Allocating 401k assets to the highest-cost, highest-risk, illiquid, least transparent investments ever devised by Wall Street will expose workers to further risk of losses in the ongoing pandemic and accompanying financial crisis. The pandemic and related financial fallout has precipitated private equity investor redemption requests and damaged many private investment portfolio companies.
Why would Trump’s DOL and SEC push workers to put their 401k savings into these risky funds when existing investors are struggling to redeem—to get out?
Someone may be getting COVID relief but it ain’t workers like you.
One commentator, PitchBook, recently noted that private equity exit activity in 2020 Q2 collapsed as firms sharply marked down portfolio companies and chose to hold investments.
PitchBook noted “PE firms sharply marked-down portfolio companies during the second quarter of 2020,” and:
“Heavy debt loads and the pandemic crisis forced several portfolio companies into bankruptcy. Other portfolio companies may be headed that way, as credit rating agencies downgraded hundreds of PE-backed companies. PE holding times are likely to balloon as we saw during the global financial crisis as sponsors put off exiting until the future is clearer.”
The International Finance Corporation similarly noted the negative impact COVID-19 is having on PE funds, especially in the emerging markets, due to the reduction in activity and growth prospects of fund portfolio companies.
IFC notes that the pandemic is affecting the short-term (one year) and medium-term (two to three years) growth prospects of funds’ portfolio companies, which are generally experiencing negative impacts on revenues, costs, and profitability. IFC believes heightened risk aversion could lead to heavy growth in borrowing, bankruptcies, and defaults. “The combination of demand shocks reducing income availability and supply shocks disrupting global value chains is impacting entire business lines and sectors. . . .” IFC noted in the short term, returns for PE funds in emerging markets will take a hit due to significant write-downs in portfolio companies’ valuations, exchange rate volatility, and challenges in exiting investments.
McKinsey also noted in a recent paper that the global PE portfolio had declined roughly 20%. McKinsey noted about 50% of the industry’s assets under management are in vulnerable sectors, and concluded that “[a]t the end of the day, investors should brace for increased volatility, downgrades, and defaults” with private equity.
Another report by McKinsey noted that valuations amidst the pandemic “[f]or the most part . . . are lower because the performance of business, at a time when demand has been collapsing, is uncertain and public equity multiples are volatile,” and PE exits have “all but stopped” due to the pandemic.
Bain & Company noted a sharp drop-off in buyout and exit transactions, and that drop-offs in investments should be expected as 2020 continues. Bain also noted heightened illiquidity, with exit transactions falling 72% between the beginning of 2020 through April, as funds ride out the storm before even thinking about selling. Bain noted that 83% of general partners indicated in a survey that they do not expect to exit any of their portfolio companies over the next year.
Bain noted that returns will lag in a downturn because mark-to-market calculations are not immediate, and that it is “difficult to value companies in this environment, given the disruption to company cash flows, market volatility and the lack of comparable transactions.”
In an environment of “heightened risk aversion,” as noted by the IFC, encouraging workers to gamble their already-battered 401k retirement savings in private equity is indefensible. Calling it “COVID relief” is reprehensible.