Retirement is expensive. If you’re lucky, yours will last a few decades, and you’ll be earning no or very little income. So if you want to have enough money when you retire, you basically have three options: Save more, take more risk with your investments, or work longer.
Many people find the first and third options undesirable or impossible. That leaves the second option. And despite what people such as Marc Rowan might lead you to believe, there’s really no way to get a higher return without taking more risk.
Rowan, the CEO of Apollo Global Management, wants to allow Americans to invest more of their retirement money in private assets—credit and equity that aren’t sold in public markets. The practice, as he points out, is allowed in Australia, which is so pleased with its success that it plans to double its exposure to private equity in some accounts. The U.K. is also considering increasing its exposure for its retirement savers. In the U.S., however, only accredited (read: wealthy) investors have direct access to such assets.
As Rowan sees it, people invest for their retirement for the long term. One reason private assets promise a higher return is they are less liquid. If you give your money to a private equity fund, it invests in assets that aren’t publicly traded, so you can’t sell them if you need to. After several years, the fund matures, and you get your money back with some return.
In theory at least, you have been compensated for giving up liquidity with a higher return. If you don’t need liquidity—like most retirement savers, Rowan argues—you may as well get that illiquidity premium.
Rowan is correct that public assets aren’t as safe as many people think (GameStop, anyone?), and private assets aren’t as risky. But that doesn’t mean private assets are safe—especially for inexperienced people investing for their retirement. A comparable public asset is less risky not only because it is more liquid, but also because it is more transparent. It is subject to more regulatory scrutiny and carries a market price, which conveys a lot of information about its present and future value and imposes more accountability on corporations.
It’s possible to argue that publicly sold assets are riskier because that market price is constantly updated, making them prone to runs and bubbles (see GameStop, above). Yes, prices collapse—sometimes justifiably, because the market overvalued an asset or a company, or because some news changes the value of the asset. In private markets, these issues can be obfuscated for years. There will eventually be a market reckoning, but it will come much later.
Even the best private equity and credit managers are prone to groupthink and not seeing huge risks. Private credit is presumed to be less risky, for example, because its less subject to runs and there is less duration risk. But there is still credit risk, because the interest rate is floating and that means more default risk, especially in a rising-rate environment. Even the smartest people can be blind to big risks—and a market price, on which a lot of smart people are making different bets that are transparent to everyone, is the best insurance against groupthink.
Then there is the question of how investments in private assets would perform if expanded to the retail market. They have performed well in the past, but research suggests once public pensions started investing more in private assets, the funds did less well. Private markets seem to work better when they are smaller and fund managers can be more choosy. Expanding their size and scope also can make markets riskier overall. So far, regulators are confident private credit does not pose much systemic risk—despite its opacity—but if the market grew bigger, so would the systemic risks.
All this said, Rowan is onto something when he talks about spending in retirement, as opposed to saving for it. There are a dearth of good products and strategies to help retirees spend their assets. In 2009 Apollo started Athene, an insurance company that offers annuities. The U.S. annuity market, which is still thin and does not offer much in terms of inflation-linked products, is in desperate need of innovation and competition. Athene’s annuities pay a fixed amount, and the underlying assets are invested in private markets.
Depending on how well it is regulated, and the fees involved, this may be a good use of private markets, in which many insurance companies invest already. An insurance company is better poised than an average investor to take on risk, and is on the hook if the assets don’t pay out.
Illiquidity premium or no, when it comes to investing retirement assets in private markets, the golden rule of finance still applies: There is no extra reward without added risk.
Allison Schrager is a Bloomberg Opinion columnist covering economics. A senior fellow at the Manhattan Institute, she is author of An Economist Walks Into a Brothel: And Other Unexpected Places to Understand Risk.