The Impact of Being Able to Invest in Hedge Funds in Your 401(k).

Soon you’ll be able to invest in hedge funds through your 401(k). How ironic.

A recent executive order aims to remove barriers preventing employees from accessing “alternative assets”—including hedge funds and private equity—in their 401(k)s. Investment firms are preparing for this shift, developing retail-friendly versions of hedge fund strategies that will be as easy to select in your 401(k) as an S&P 500 index fund.

Hedge funds are private investment partnerships that use aggressive strategies like short selling, leverage, derivatives, and activist company take overs, to generate returns, typically charging high fees for actively managing concentrated portfolios. Unlike the mutual funds and ETFs currently available in most 401(k)s—which are heavily regulated, transparent about their holdings, and required to allow daily redemptions—hedge funds operate with far less oversight, can lock up your money for extended periods, and don’t have to disclose what they’re investing in.

The order frames this as “democratizing” access to these investment products.

But is this really such a great opportunity?

The performance record of hedge funds as compared to the general stock market is underwhelming. When Warren Buffett bet in 2007 that an S&P 500 index fund would outperform hedge funds over a decade, it wasn’t close. Nine years in, the hedge fund portfolio had gained just 22 percent while the index fund soared ahead.

Overall, research suggests that outperformance is “scarce and difficult to obtain in the hedge fund market, especially among those listed in commercial databases. Furthermore, most studies report that outperformers fail to repeat their feats over long periods.” (“Beyond the Hype: Do Hedge Funds Deliver Value?”)

These investments also come with the notorious “2 and 20” fee structure—2 percent annual management fees plus 20 percent of profits—though competition has pushed average fees down to around 1.4 percent management and 16.4 percent performance fees. Meaning, the risk lays entirely with the investor who pays management fees in bad times, and even higher fees in good times.

Why Most People Couldn’t Invest Before

Hedge funds were historically restricted to “accredited investors”—individuals with net worth over $1 million (excluding primary residence) or annual income above $200,000 ($300,000 with a spouse)—because they use complex, risky strategies with less regulatory oversight. They can leverage investments, short sell, and invest in illiquid assets deemed too dangerous for ordinary retirement savings. The executive order acknowledges fiduciaries must “invest safely and prudently” but focuses on removing what it calls burdensome regulations and litigation risks, directing the SEC to consider revising accredited investor requirements.

The Core Irony

The irony is stark. Activist hedge funds are known for acquiring stakes in companies, pushing for “operational efficiencies” (layoffs), demanding cost cuts, and pressuring management to prioritize quarterly returns above all else. They operate on the timeline of earnings reports and redemption windows, not careers or communities. They are committed to prioritizing shareholders over all other stakeholders—including employees. See “Disentangling the effects of hedge fund activism on firm financial and social performance” by DesJardine and Durand, Strategic Management Journal (January 2020).

But soon workers will be able to fund these strategies with their own retirement savings—potentially investing in funds that later take positions in their own employers and advocate for restructuring that eliminates their jobs or reduces their benefits. Retirement accounts designed to provide long-term security may soon be channeled into vehicles that actively undermine present-day job security as well as retirement security through riskier, more expensive hedge fund investment options. Isn’t it ironic?

Ms. Money is written by Marisa Rothstein, JD, CFP(t), AEP, and Lead Financial Advisor at Siena Private Wealth, A Member of Advisory Services Network, LLC.

Nothing contained in this article should be construed as investment, legal or tax advice. Consult your tax or legal advisor regarding your situation. To learn more about Siena Private Wealth, visit: www.sienaprivate.com. All information contained herein is derived from sources deemed to be reliable but cannot be guaranteed. All views/opinions expressed in this newsletter are solely those of the author and do not reflect the views/opinions held by Advisory Services Network, LLC.