Biden administration is keeping a close eye on private equity and other ‘alternative’ investments

The Biden administration is lending a more cautious eye to private equity and other “alternative” investments like hedge funds.

The U.S. Securities and Exchange Commission and U.S. Department of Labor have taken steps in recent weeks to boost transparency for investors and rein in the pool of retirement savers who can buy private equity.

The investment category is generally off-limits to anyone who isn’t an “accredited” investor — someone deemed to have a minimum level of income, wealth or expertise to participate. (Retirement plans pose a slightly different dynamic; in this context, the employer acts as a gatekeeper that can choose to make private equity available to its workers.)

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“The Biden administration, through various agencies, is taking a deliberate look at the potential impacts of the private equity market, especially on retail and retirement investors,” said Dylan Bruce, financial services counsel for the Consumer Federation of America, an advocacy group.

What regulators are doing

The SEC on Feb. 9 proposed a multi-pronged rule to increase transparency, by requiring private-equity funds to issue quarterly statements detailing fees and performance, among other things.

It would also limit the preferential treatment some investors get, such as additional disclosures that may have a “material negative effect” on other investors, according to the SEC. It would also require an annual audit of private funds and prohibit funds from engaging in certain conflicts of interest.

Separately, the Labor Department published a notice on Dec. 21 designed to limit the scope of Trump administration guidance from June 2020.

The Trump-era labor agency laid out legal parameters for employers to consider if they’d like to offer employees a 401(k) plan fund with an allocation to private equity. But the Biden administration limited the memo’s application, though didn’t repeal it.

Specifically, the agency said employers already managing private equity for the company pension plan are likely best suited to analyze whether private equity makes sense for their 401(k); the department “cautions” other companies (i.e., those not fluent in private equity) from doing so.

“They put more ‘guardrails’ about what the June 2020 letter said,” Julie Stapel, a partner at law firm Morgan Lewis, said. “It’s not an endorsement or acceptance of widespread use of private equity … without that prior expertise and experience.”

More investors

The additional regulatory focus is largely because the market and access to private funds (like private equity, venture capital and hedge funds) have grown in the past few decades.

The funds hold $18 trillion in gross assets, according to SEC chair Gary Gensler. Globally, private equity assets have grown tenfold since 2000, about three times the pace of public stocks over the same period, according to McKinsey, a consulting firm.

Further, 16 million households were eligible to buy private funds in 2019, up from 1.3 million in 1983, according to SEC data.

That amounts to 13% of all U.S. households in 2019, versus 1.6% in the early 1980s. The share likely increased after 2020, when the Trump administration expanded the pool of accredited investors.

“Sometimes, [the investors] are wealthy individuals,” said Gensler, who was appointed by President Joe Biden. “Often, though, they’re retirement plans, like state government pension plans, or non-profit and university endowments.

“The people behind those funds and endowments often are teachers, firefighters, municipal workers, students, and professors,” he added.

Consumer advocates worry about increased access. Private investments carry more risk and opacity and have less liquidity if an investor needs their money, they said.

Performance

But proponents tout the higher return potential of private equity relative to the public stock market.

Private equity yielded a 15.7% net annual rate of return, at the median, over the past decade, relative to 14.8% for the S&P 500 Index, according to an analysis by the American Investment Council, a trade group representing the private equity industry.

“The [regulatory] guidance reaffirms that private equity is a valuable investment option and an important part of a diversified portfolio,” said Emily Schillinger, a spokeswoman for the American Investment Council, a trade group. “A wide range of data confirms that private equity delivers the strongest returns to public servants and retirees across America.”

The performance gap between private equity and public stocks has “narrowed,” according to a report by Michael Cembalest, chairman of market and investment strategy at J.P. Morgan Asset Management.

Source: CNBC

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