Private Equity In Your 401k? Just Say No

We have a couple of different articles about private assets being available or otherwise worked into 401k plans. 

First is 401k provider Empower starting to rollout private equity, credit and real estate into plans they offer, ranging from 5-20% allocations. This quote made my eyes bug out. "Wall Street firms have been pushing to get private investments into the hands of individual investors, and they see the $12.4 trillion market for 401(k)-type retirement plans as crucial to this growth."

I'm always going to read something like that to mean we need more suckers. To call the current goings on with private equity and private credit a bubble as relates to giving individuals access probably isn't correct, I don't think the space is big enough at this point. The entire private credit and private space is probably large enough to be a problem akin to a bubble but I'm not sure there's enough homogeneity to tie it all together into a systemic event like mortgages through the banking system.

The first time I was on CNBC it was to talk about solar stocks. I was asked if the group was a bubble. I said no because it was too small to be a bubble. The whole group could disappear without making a dent in the stock market. The better word was mania. I think private equity and debt is closer to a mania on that scale. 

But, if you like private credit then you'll love leveraging up 4-1 to buy it in your 401k through a company called Basic Capital. Here's the gift link from Bloomberg. The very short version of this is that 15% goes into an equity index fund and 485% goes into private credit. The yield from the private credit should more than cover the interest expense, there is interest, and the fees and the yield that is left over, when levered up and combined with the modest exposure to equities should give a low double digit return. 

I really am simplifying that. 

This is of course interesting stuff. It might be insane but it can be interesting and at a high level is a building block for risk parity. 

The four portfolios put 15% in the S&P 500 and 485% in the fund named in the portfolio. I played around with some other funds too. The drawdowns can be brutal and although the backtest doesn't show it well, just about all of the different portfolios did endure some really big declines. 

The program doesn't have margin calls though. It is treated more like a mortgage (read the article). 

Equal weighting the four (subject to rounding) and then comparing to VBAIX.

There's a little less volatility and quite a bit more growth but there was no crisis alpha in 2022. The drawdown that year wasn't catastrophic compared to VBAIX but was a little worse. If this levered 401k platform really does invest in private credit then the risk of statement shock would be less because of how private assets (don't) mark to market. Cliff Asness calls this volatility laundering. 

There wouldn't be a problem unless....

It would be difficult to get used to not getting at least daily marks on something like this. I am not saying people should check their 401ks every day but any day that someone does check, the information should be current. 

Usually when we look at these sorts of complex products I will say that whatever you're trying to do, there's probably a simpler and cheaper way to do it. The closest I can think of to replicate this in a simple fashion would be 15% in an S&P 500 fund at 85% in the Simplify Short Term Treasury Futures Strategy ETF (TUA) which leverages up the two year treasury 5x. When I plug that combo into Testfol.io, it only compounds at 1.70%, far less than the blend we looked at and VBAIX but with more volatility than both. The intended use for TUA is for capital efficiency not for leveraging up like this.

Some of the AQR funds do different things with leverage but the to the best of my knowledge those funds are more balanced like maybe 400% long and 300% short. 

The strategy that Basic Capital is offering is legitimately interesting but I don't believe there is mechanism where the strategy could exist in a fund at least for now. I am going to naturally be biased against using something so complicated, illiquid and expensive. I can't get to a point of thinking the potential reward is worth the risks.

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