Private, but Not Always Prudent
Private investments have always had a kind of cachet. There is a sense of exclusivity, mystery, and of course the promise of higher returns. Much more interesting to talk about that hot new fund you got access to over cocktails than the returns you got on your index-tracker last year.
Up until recently, private equity and private credit have been the near sole preserve of institutional investors, family offices and UHNW individuals. That’s now changing.
The largest private market asset managers are making a concerted effort to (as they like to put it) “democratize” access to private equity and credit. This commercial push has been accompanied by a lobbying effort which poured a quarter of a billion dollars into our political system in 2024 alone. We should therefore not be surprised that the gates are swinging open.
The Department of Labor authorized private equity exposure within (otherwise liquid and diversified) funds in 401(k)s in 2020. This year (2025) the SEC lifted implied restrictions on leverage in closed ended funds open to non-accredited investors, and the SEC is currently considering fully legitimizing private market fund offerings within 401(k)s.
This effort to tap retail investors comes at a time when institutional fundraising for new private equity funds has been declining for almost three years. A new source of AUM growth is needed. Fund sponsors are salivating at the prospect of tapping the huge mass-affluent market, which is larger in AUM terms than the entire global pension system. 401(k) platform providers are also eager to participate, both because it may differentiate their offering to employers and because they share in the larger fees generated by the investments plan participants purchase. Brokerage platforms too are broadening their offerings of private funds for advisor-led accounts.
There are reasons for advisors to be cautious:
Performance potential: There are good reasons why institutional investors are pulling back on their allocations to private equity. The valuations on many private equity funds have become suspect. Higher interest rates have barely been reflected in NAVs. IPOs, liquidations and return of capital from private equity funds to their limited partners have been meager for years. Fund sponsors are increasingly selling assets amongst and in-between funds they manage, rather than at arm’s length. “Continuation funds” have proliferated. It feels a lot like they’re looking to retail investors as “exit liquidity.” It smells like a mix of desperation and predation.
Sky high costs: It’s hard to overstate the cost on private fund investments. Not only do they often take the form of fund-of-funds for retail investors, they also often carry platform fees. Depending on what you count, all-in costs tend to range from 3-4% annually, even without counting the cost of leverage. Including the cost of leverage and higher operating costs, the expense ratio can be even higher. The cost structure strongly exacerbates the natural “heads-I-win, tails-you-lose” dynamic that prevails in the asset management industry.
Higher than expected risks: Private market promoters like to tout low-correlations and diversification. This is almost entirely a mirage. It’s a function of illiquidity, mark-to-model pricing, and infrequent NAVs. Beyond that, the application of leverage and one-sided performance fees means these investments will almost certainly surprise investors to the downside in ways that are not commensurate with the return potential. We would argue that this stands in contrast to the stock or bond market where everyone has visibility on the risks, if they care to look.
We don’t want to imply that private assets are “bad” or that they’ll necessarily perform badly net of fees. However, we feel that the marketing for private assets has exceeded the merits, particularly as it applies to the average retail investor. Private investments can play a productive role in the portfolios of well-informed, high-net-worth individuals with long investment horizons and adequate risk tolerances. But we worry that does not describe the average 401(k) participant, and that advisors may find it hard to push back against the impulse to go for the “hot new thing” amongst clients. Watch your allocations carefully and allocate with your eyes wide open.