Want More Flexibility for Your 401(k) Portfolio? The Department of Labor Just Made It Happen.

Earlier this month, the Department of Labor (DOL) took a major step towards offering more investment options for Americans with 401(k) plans. In an information letter, DOL said they will allow defined contribution retirement plans, including 401(k) plans, to invest in private equity (PE), an option that is typically only available to defined benefit (pension) funds.

Labor Secretary Eugene Scalia helped explain how beneficial this flexibility will be for the tens of millions of Americans who have access to a 401(k) plan:

“This Information Letter will help Americans saving for retirement gain access to alternative investments that often provide strong returns. … The Letter helps level the playing field for ordinary investors and is another step by the Department to ensure that ordinary people investing for retirement have the opportunities they need for a secure retirement.”

The move may come under attack from more liberal members of Congress, who have recently criticized PE companies that they think are looking to engage in predatory acquisitions during the COVID-19 economic downturn. (NTU and 28 other free market organizations rejected these arguments, and pointed out that mergers and acquisitions can save companies and jobs from going extinct, in a recent coalition letter.)

However, research indicates that global PE outperforms the U.S. stock market. According to a 2019 study from experts at UNC and the University of Chicago (emphasis ours):

“Accounting for the different amounts of capital in each vintage year leaves an excess return of 3.5% or 1.15. In other words, U.S. buyouts [“which represent the largest part of global private equity,” according to the authors] have historically outperformed the S&P 500 by a fairly wide margin.”

In other words, PE has historically outperformed publicly traded companies on the stock market by 3.5 percent. Combine this with data that indicate the number of public U.S. companies has been cut in half over the last 20 years, and there’s an even more compelling case that tens of millions of Americans with 401(k) plans should have access to the potential gains of PE investments.

Of course, PE investments are often structured in a more complicated manner than publicly traded companies or funds, and the average American investor may not have access to the same kinds of information they do with a company that trades on the NASDAQ or S&P 500 exchanges. For that reason, DOL is not making PE investments “available for direct investment on a standalone basis,” but instead limiting PE investments to one part “of a professionally managed multi-asset class vehicle structured as a target date, target risk, or balanced fund.” This is a prudent limit on these new flexibilities offered by DOL.

Overall, this move has the potential to offer up great opportunities and great returns for many Americans saving for retirement. At a time of unprecedented upheaval in the stock market, PE investments can represent a promising alternative for millions of investors looking for strong returns at an uncertain time. DOL should be applauded for their efforts.