654. Is the Public Ready for Private Equity?

Episode Summary

Executive Summary: The episode examines whether expanding 401(k) access to private equity, private credit, crypto, and other alternative assets is a democratizing opportunity or a costly mistake. Experts argue private markets have historically outperformed in some eras, but retail investors face high fees, illiquidity, opaque pricing, and likely lower-quality access just as institutional capital is pulling back.

Main Topics: Opening case for and against alternative assets (Priority: 5/5): The episode contrasts common retail investment choices—sports betting, lotteries, crypto, index funds—with the claim that private equity has outperformed public markets, setting up the question of whether new access for retail investors is beneficial. Private equity’s growth and changing investor base (Priority: 5/5): Private equity has expanded rapidly from a niche 1980s asset class into a massive industry now seeking retail capital because institutional money is increasingly tapped out and returns have softened. Regulation, transparency, and market power (Priority: 5/5): Elizabeth DeFontenay explains that private equity operates in lightly regulated spaces, with limited disclosure and potential antitrust, labor, and pricing concerns when firms roll up small businesses in fragmented industries. Performance history of private equity (Priority: 4/5): Steve Kaplan argues that buyout companies and many private equity funds have historically beaten public-market benchmarks net of fees, although recent vintages have struggled due to high entry prices and rising rates. Retail investors, fees, and illiquidity risks (Priority: 5/5): Both guests warn that retail investors may face layered fees, weaker deal access, and liquidity problems if private assets are embedded in 401(k) target-date funds or similar vehicles. Policy shift under the Trump executive order (Priority: 4/5): The executive order directing agencies to expand access to alternative assets in retirement plans is framed as a major deregulatory change that could channel trillions of retirement dollars into private markets. Long-term effects on public markets and the economy (Priority: 4/5): The discussion ends with concern that shifting capital away from public markets could weaken passive investing, shrink public-company breadth, and create more scrutiny and litigation for private assets.

Key Arguments: Sports betting and lotteries are negative-expectation bets; crypto is volatile but may be a fair bet if fees are low, while low-cost index funds remain the strongest simple retail investment. Private equity became attractive because, for many decades, buyout funds and portfolio companies often delivered returns above public-market benchmarks after fees. The Trump executive order could be a major policy turning point because it instructs regulators to remove barriers to alternative assets in 401(k)s. Private equity raises capital with little disclosure and few obligations to investors, making it a very lightly regulated segment of finance. Private equity’s success in rolling up small businesses can create antitrust, pricing, and labor concerns, especially in fragmented local markets. Retail investors are likely to receive inferior access: higher fees, more packaging layers, less transparency, and potentially lower-quality deals than institutional investors. The industry is pursuing retail money because institutional capital is increasingly exhausted and returns are under pressure. Public markets remain the best environment for ordinary investors because prices are more transparent, liquid, and close to correctly valued, enabling cheap indexing. Embedding illiquid private assets in 401(k) target-date funds could create liquidity mismatches and make it harder for retirees to access their money. Expanding retail participation may increase scrutiny, litigation, and regulation, potentially changing private equity and venture capital into a different and possibly worse product.

Data Points: Private equity share of U.S. corporate equity: about 20% - DeFontenay says private equity is thought to control roughly this share, up from around 4% a couple decades ago. Private equity funds in the U.S.: around 19,000 - A sign of how crowded and mature the industry has become. Growth in private-equity-owned physician practices: up around 700% since 2012 - Example of private equity expansion into healthcare services. Average fund fees: 20% of profits + about 2% annual management fee - Describes the standard '2 and 20' model that retail access may replicate or layer on top of. Typical private-equity leverage today: about 50%–60% debt - Kaplan contrasts current buyout leverage with the much higher leverage of the 1980s. Historical leverage in 1980s buyouts: 80%–90% debt - Used to explain why early leveraged buyouts were riskier and later rebranded away from the term 'LBO'. Default rate on 1987–1988 leveraged buyouts: about 40% - Kaplan cites this as evidence of excessive leverage in the junk-bond era. Illustrative buyout return example: $50M equity becoming $150M - Kaplan’s example of buying a $100M company with 50% debt, improving value to $200M, and tripling equity. Years in Kaplan’s sample that beat the S&P 500: 25 of 27 years before 2020 - He says almost every vintage of buyout funds outperformed the S&P 500 net of fees. Public companies listed in the U.S.: 7,300 in 1996; 4,300 last year - Used to argue that public markets have become narrower even if market cap remains large. U.S. retirement savings in 401(k)s: around $13 trillion - The potential pool of retirement capital that could be redirected into private assets. Possible share of 401(k) money flowing to private markets: about 10% - DeFontenay’s estimate if the industry gets its wish, direct or indirect. Private equity’s origin: 1980s - The industry is described as a relatively young asset class.

Pivotal Quotes: "I think the party is over in the private markets." — Elizabeth DeFontenay: Her assessment of the current state of private equity and venture capital as institutional money becomes crowded out and retail money is invited in. "Retail investors always do better when they are indexed in the public markets." — Elizabeth DeFontenay: Her core argument that low-cost public indexing is superior for ordinary investors compared with trying to pick private assets. "Those funds, net of fees, beat the S&P 500." — Steve Kaplan: Kaplan summarizes his research on buyout fund performance over long time horizons.

Implications: Retail access to private markets may enrich fund sponsors and deepen fees, but it likely increases risk, opacity, and liquidity problems for savers. The policy could also reshape public markets and force more regulation, litigation, and scrutiny around private assets.