- Key insight: The Department of Labor's proposed rule to allow 401(k) plans to offer alternative investments corrects a long-standing asymmetry.
- What's at stake: Restrictions that limit access to private market investments are harmful to ordinary investors, who are denied better returns. They also seal off a large potential source of funding for long-term infrastructure investments.
- Supporting data: Private-market assets are roughly $20 trillion today and are on pace to exceed $32 trillion by 2030.
In March, the Department of Labor proposed a rule that would let 401(k) plans offer alternative investments — including private equity, private credit, real estate and infrastructure.
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The asymmetry this proposed rule change corrects is significant. The average university endowment held about 54% of its assets in private and alternative strategies; in funds above $5 billion, private equity and venture capital make up one-third of all holdings. But while pensions and sovereign funds invest this way, most households cannot since the SEC's "accredited investor" registration prohibits people below a wealth threshold from investing in such assets.
But private markets are far from being risky, "fringe" markets: Private-market assets are roughly $20 trillion today and are on pace to exceed $32 trillion by 2030.
Private market assets have also produced solid returns without excessive volatility for some time. The standard private-credit benchmark has returned 9.5% a year over two decades, with one losing year in 2008. Private equity's record is more robust, with an average 15.3% annual return, net of fees, over the last decade — compared to 13.4% for the S&P 500. Furthermore, private equity's returns are not synchronous with public markets, thus delivering diversification that all savers can benefit from.
For example, the perceived safety of the standard 60/40 portfolio is predicated on the assumption that when stocks fall, bonds rise, thus limiting damage during downturns. Yet, in 2022 both indices fell, for the first time since the 1970s, and the stock-bond correlation hit a 40-year high near 0.68. That year, the standard 60/40 portfolio lost about 16%. Assets uncorrelated with public markets — such as private equity — can provide a hedge.
The objection to private equity is, in essence, an objection to its very structure. Private funds lock up capital for years and mark their value only periodically, while a 401(k) saver receives daily prices and ready access.
However, attempts to impose greater liquidity in the market can backfire. For instance, several colleagues and I studied the SEC's 2018 liquidity Rule 22e-4, and found U.S. bond funds raised liquid holdings about six points above Canadian peers — yet grew more fragile. Facing 2020 redemptions, they sold illiquid securities to protect the mandated buffer, and a one-standard-deviation rise in such sales cost about 0.7 points of return. We found that liquidity that must be held is not the same as liquidity that can be used.
We should not use illiquidity as a reason to keep savers out of these assets. The potential benefits to them are simply too great. The answer is to fit the fund to the asset and not to make private credit resemble a bank account. For instance, interval funds attempt to strike a balance between liquidity and access: These have no wealth tests and allow redemptions on a regular schedule, which protects funds and allows investors to redeem in an orderly manner. The Labor Department's proposed rule provides the sensible complement, protecting savers by holding fiduciaries to a documented standard without impinging on the returns and structure of private credit.
Beyond the diversification benefits they offer, there is an additional reason for the government to encourage more investment in private credit: The economy needs an extraordinary amount of patient capital. PwC's Global Infrastructure Outlook estimates cumulative global infrastructure spending will approach $151 trillion through 2050, with a significant proportion in the U.S. It's not clear that the federal and state governments will be able to afford them given the persistent and large budget deficits that show no signs of receding. Americans hold more than $18 trillion in bank deposits, which earn a mere 0.4 percent, on average, while Treasury bills pay close to four percent. It's not that we don't have enough savings to finance these needs. We just lack sufficient channels between long-term savings and long-term investment.
None of this argues for weaker guardrails; instead, it presents the case for better ones: clear disclosure, sensible caps, suitable vehicles and accountable fiduciaries. If we get those right, widening access to private credit is no gamble. It hands ordinary savers the tools institutions have used for forty years, and aims some of that idle $18 trillion at what the country needs to build.
