America is a free country. People are allowed to take all sorts of ill-considered risks: They can day-trade put-options, bet on sports from their phones, even go BASE-jumping. But unless they are wealthy, they can’t invest in private assets.
That may be about to change. Last week President Donald Trump issued an executive order to allow people to invest their 401(k) in private assets, and meanwhile the US House is considering a bill that would allow more people to buy unregulated securities. The goal is clear — to sweep away rules that restrict Americans’ ability to invest in private equity and private credit.
I consider myself libertarian-ish politically, and tend to be suspicious of government regulation. And from a financial standpoint, I think investors are generally underexposed to risk; most people could stand to take a few more chances with their portfolios.
And yet: I am wary of this push to democratize private investment. Let me explain why.
Investing is hard. For investors, collecting all the necessary information can be boring, and takes expertise most people don’t have. From a corporation’s perspective, there is not always an incentive to be fully transparent about finances — not necessarily for nefarious reasons, but maybe because it expects things to turn around soon. Or maybe it is reluctant to reveal gory financial details that market analysts can then pick apart.
All this helps explain why there are so many financial regulations. People learned the hard way what happens when equities aren’t well regulated: Markets crash and the little guy gets burnt. In the years after 1929, there was a flurry of regulations aimed at making investing safer and more transparent. One of them was the “accredited investor” rule, which requires people to meet minimum thresholds for income (at least $200,000 annually) and wealth ($1 million, not including their primary home) before investing in unregulated assets. These characteristics were seen as proxies for financial sophistication, or at least the ability to endure a bad decision.
It sounds outrageous. Why do only rich people get to invest in certain assets? But the accreditation requirement was not much of a constraint for most of the 20th century. Not only were there few compelling private investment opportunities, but until the 1980s, when 401(k)s became popular, most Americans did not even invest in the market at all.
That’s no longer the case. At least 60% of Americans are now investors in the market, usually through their pension account. Meanwhile, the market for private assets has become larger and more appealing. Pension funds, endowments and insurance companies have piled into private assets in the last few decades. They provided so much capital that many companies no longer needed to go public to fund their growth, and were more than happy to avoid the regulatory scrutiny. Now many of America’s fastest-growing companies are staying private (and lots of bad companies are, too). Until last week, 87.4% of the population couldn’t invest in them.
The timing of these rule changes is not ideal. There are reasons to think private equity has peaked, and private credit also faces some worrying headwinds. A lot of its debt is issued at a variable interest rate, and borrowers may struggle to pay their loans if rates stay high. Also, not all vintages of private funds are equal. Odds are that funds will keep their better vintages for big institutions, or wealthy people, who won’t need liquidity and can pony up big capital.
Honestly, it’s hard to say what will happen — and that itself is a problem. There is very little transparency in the world of private investment, and private funds don’t have much incentive to be more forthcoming. Markets, for all their faults, are pretty good at incorporating information into an observable price.
To be sure, there are legitimate concerns about how to define an accredited investor, and the classification needs reform. A test of financial literacy, which the new bill proposes, makes more sense than the current wealth and income test. The existing system also favors older people on the cusp of retirement who tend to have more wealth. Moreover, a lot of rich people aren’t sophisticated investors and are just as capable of losing all their money as not-so-rich people.
Allowing private assets into 401(k)s is more concerning, because the result will be much more access to private markets with much fewer constraints. The good news is that most people stick with the default investment their plan sponsor chooses for them — and for the time being at least, few plans will choose to include private assets.
The bottom line is that accreditation is a government regulation that exists for a good reason, and that reason has not changed. This isn’t just an example of the government’s paternalistic instinct to intrude in people’s lives. It’s an acknowledgement that it is sometimes impossible to make a well-informed choice. If Americans want to take risks — and they do in private markets — then they need transparency.
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