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
Private equity gambling—ramping up the fees and risks to
401k savers—will help workers “overcome the effects the coronavirus had had on
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
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
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
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
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