Fix It Friday Ep. 17 - Private Equity in Your Retirement Plan: Opportunity or Trap? Why Private Markets Are Targeting Small Investors!

•  Private investments can appear safe or exclusive, but often shift risk from firms to individual investors
• Behavioral biases like FOMO and affinity bias can lead to poor decision-making in private markets
• Faith, patience, and discipline in investing guide behavior, while allocation, diversification, and rebalancing manage portfolios effectively

Disclaimer: [00:00:00] The following podcast by Fusion Family Wealth, LLC Fusion is intended for general information purposes only. No portion of the podcast serves as the receipt of or is a substitute for personalized investment advice from Fusion or any other investment professional of your choosing. Please see additional important disclosure at the end of this podcast.

A copy of Fusion's current written disclosure brochure discussing our advisory [00:00:15] services and fees is available upon request or at www.fusionfamilywealth.com. 

Jonathan Blau: So welcome to another episode of Fix It Friday. I'm your host, Jonathan Blau, and today I'm gonna pull back the curtain on private investments, which are [00:00:30] exclusive deals that the biggest firms on Wall Street like Blackstone, Goldman Sachs.

And BlackRock are so eager to put into our portfolios all under the shiny banner of what they call democratization of private [00:00:45] investments. So what does that even mean? So until recently, private investments are just simply investments that don't, uh, trade or, or aren't available on the public exchanges like the New York Stock Exchange, the same way you might buy shares of IBM [00:01:00] or Apple Computer.

That's what a private investment is. They're only available, uh, through, through avenues that are not, uh, uh, on the public markets. And what you're gonna learn today is that, in my opinion, [00:01:15] what the big firms are doing is not suddenly having a warm heart and saying, why are we holding back the investment public who aren't among the wealthiest from getting the, uh, opportunity to invest in these wonderful private investments?

Let's open it up. [00:01:30] Let's democratize it so that everybody can participate. I don't think. That's actually what's behind the effort to quote democratize. So let's talk about it. Let's, let's lift the curtain a little bit today. It's just gonna be me and you, no guests, [00:01:45] and there's gonna be some straight talk that nobody on the podcast here will hear at their favorite country club.

Voiceover: Welcome to The Crazy Wealthy Podcast with your host, Jonathan Blau. Whether you're [00:02:00] just starting out or are an experienced investor, join Jonathan as he seeks to illuminate and demystify the complexities of making consistently rational financial decisions. Under conditions of uncertainty, he'll chat with professionals [00:02:15] from the advice world, entrepreneurs, executives.

And more to share fresh perspectives on making sound decisions that maximize your wealth. And now here's your host. 

Jonathan Blau: So first, let's [00:02:30] remind ourselves why are private investments so seductive? For the wealthy. So there's something called affinity bias. Remember, a bias is just a tendency to think a certain way, kind of innate.

And what affinity bias is really, um, [00:02:45] based on is our need to feel part of a tribe as a survival instincts over the, um, evolution of, of human uh, nature. And if we think that a certain investment will [00:03:00] reflect. Our status that we wanna reflect, uh, and will make us look like we belong to a certain group we want to belong to, then we're gonna actually wanna make the investment.

We'll have a tendency to wanna make the investment even without really, uh, [00:03:15] surveying whether or not the investment makes sense for us. In practical terms, and so affinity bias makes us crave membership in the right clubs. We are drawn to things that reflect that image that we have or the one we want others to believe we have [00:03:30] there.

There's also something called fomo, which we've all heard of, fear of missing Out, and there there's a huge investment group called TIGER 21, which is the largest or most wealthy investment group in America, if not the world, and [00:03:45] the members of Tiger 21. Always, uh, want to know what everyone else is getting into in their group of billionaires.

Some of many of them are billionaires so that they, they're almost programmed and we're almost programmed to want into, but let's not [00:04:00] forget. Also, diversification. We are told by the industry that private investments are our ballast against public market storms or bear markets. So if we remember in April, we had what was called the tariff tantrum, the s and p 500.

The broad [00:04:15] stock market declined on April 3rd and fourth, 5% each of those days for a 10% two day decline. And what was interesting to me during that decline as it relates to private investments, as I received an email from one of these big [00:04:30] private investment, uh, firms. Saying to me, as an advisor, you should consider now adopting private investments if you haven't.

And the reason is, is that it'll help your investors to stay the course during times like this, not because of the investments [00:04:45] themselves might be doing better than public investments, like the stocks in the standard and poorest 500, which moved down 10%. But because private investments, unlike the Standard Force, 500 companies that trade on the public markets.

Don't [00:05:00] reflect instant price moves down or up. It usually takes about a quarter for the investments in private, uh, companies to be updated. So the investor basically is saying to me, would be fooled into believing that this private [00:05:15] investment did better. Simply because it didn't reflect the current dislocation in the market and won't do so for another quarter.

I was almost, I, I had to read it a few times to believe what I was being told to sell to my clients. So at the end of the day, uh, it's [00:05:30] important to remember as, as far as diversifying against volatility or up and down temporary moves in the number of dollars in our portfolio because of market dislocations or bear markets.

That in, in our view, and this is important, [00:05:45] volatility or up and down movements isn't risk any more than a market dip or a temporary decline is a permanent loss. So we need to challenge these narratives in order to succeed as investors. Let's, let's talk [00:06:00] about the real reason now that some of these big, uh, private investment firms are so obsessed with opening up private investments to the mass investor, especially our 4 0 1 Ks.

This is where the agenda gets a little interesting. So [00:06:15] let's take Larry Frank, who's the CEO at BlackRock, the the largest seller of private investments, and they're a public company. They trade on on the stock exchange. So on the surface it looks like they're doing a public service. BlackRock, [00:06:30] giving everyday investors like you and me, the keys to the same kingdom that were previously reserved only for institutions like pension funds and the ultra wealthy.

When we dig deeper, you'll find something else may be at play. BlackRock, Blackstone and their [00:06:45] peers have raised staggering amounts of capital or money for private markets over the many years. And traditionally, their playbook involved investing in private companies, massaging them, nurturing them, making them even more profitable, cutting costs, [00:07:00] and then benefiting by.

Selling those private companies to the public through what's called an initial public offering or an IPO. That's simply when the public company begins to trade on the stock exchange like an IBM might, and they can profit [00:07:15] by by having that happen. But what's happened in recent times is the IPO or initial public offering market has actually slowed to a crawl, if not dried up completely.

And so there simply aren't enough companies going public to absorb [00:07:30] all of that private money. And private capital. When we add to that, the slowdown that's occurred in the traditional fundraising channels, so for example, endowments, foundations, and other institutions that typically would buy private [00:07:45] investments, they have become more selective because also the pie of private investments has not been growing.

It's been shrinking, and so, so what? What's happening is there's a need. To, to find new buyers of the private [00:08:00] investments. What's happened is a lot of the funds that hold private investments today at the big firms are actually stuck with investments that they, they can't unload readily right now. So what's the solution then for these asset [00:08:15] managers who can't unload these investments?

It's simple. They need a new exit ramp. Enter our 4 0 1 Ks by democratizing access. What they're really doing is unlocking trillions of dollars. Almost 10 trillion is [00:08:30] the number I recently saw at the value of 401k plans and retirement savings that gives them a fresh pool of buyers for assets that are otherwise stuck in illiquid private funds.

So the true wealthy clients that they [00:08:45] really wanna serve with private investments now might also have an exit ramp through the 401k uh, plans. So essentially. When they say they want to help you diversify, what? What they really need is your money or capital to buy what they can [00:09:00] easily sell elsewhere.

It's not just about growing your wealth, it's about solving their own liquidity problems and potentially at your risk. So if we think about fundraising with traditional sources, drying up direct [00:09:15] access to retirement accounts is like a golden goose because every paycheck deposited into our 401k could be one more stream.

Supporting the the illiquid private portfolios, making up for institutional money, pulling back, and the [00:09:30] public market bottleneck, meaning not being able to bring these private companies through initial public offerings to cash out. The shine of private is used sometimes cynically to move their investments off of their books [00:09:45] along with the risk and move the same onto your books.

So let's take a quick detour into what are called CMOs or collateralized mortgage obligations. And this is a little bit of a personal story among my 35 plus years of experience in the [00:10:00] business, what these collateralized mortgage obligations were as a fancy term for loans. To people who were underqualified buyers of homes, uh, and, and who wanted to put very little money down to buy these homes.

This was [00:10:15] happening in oh 5, 0 6, 0 7. And so I'm saying this tongue in cheek, but basically what was happening is people who are underqualified, let's say to borrow 10% down or 50,000 to buy a $500,000 home, were writing their income. Let's say they said they [00:10:30] make $500,000 a year and their assets or investment value of 2 million on the back of a of a napkin, giving it to the banker and then they were approved for the loan.

So now there were all these risky loans and if, if loans, in terms of a risk scale, a [00:10:45] a would be the, the, the, the least risky loan I'm making. So someone who really had a good chance of paying me back and d would be the, the riskiest. Someone who really had very little chance. A lot of these were said to be C type loans on average, but what the industry did is they figured out through [00:11:00] magic alchemy to take these loans.

So when Citibank, for example, would make a loan to someone of 50,000 to buy a $500,000 home, Citibank would make the loan. That becomes an asset on their. Balance sheets. In other words, that's that's on their inventory shelf, a loan that's [00:11:15] worth something. They could sell that loan to a third party. So let's say they sell it to, to, to, to, um, Goldman Sachs.

Goldman Sachs now takes all of these underqualified C rated loans, puts them in a fund, and then they sell it to the public. [00:11:30] And, and when they sell it to the public in the fund, the conspirator back then in oh eight and oh nine was standard. And Poors Standard. And Poors is one of the. Top agencies that rates these types of, of investments or loans.

[00:11:45] So they can be rated from AAA all the way down to D and maybe even less. So what happened is they put all these loans into a fund that was C rated or so, and because they were all together, somehow s and p said, oh, now it's AAA fund. And [00:12:00] essentially we all know what happened. That's actually what brought down the whole global financial system.

In, in, uh, 2008 and oh nine. So at Citigroup, where I had been employed at the time, they had a fund called the Falcon Fund, which was a fund that [00:12:15] aggregated all these loans. And they said to advisors like me and the wealthy clients that we served, that we should be telling our wealthy clients that the Falcon Funds offered about a time, I think it was about a 7% yield, which was a very high yield, but [00:12:30] with the same risk as a riskless.

Bond investment or a US treasury. And of course that sounded too good to be true, but they made it sound like they had some magic. And this would be available at other firms like Goldman Sachs, for example. And if we didn't present it to our clients, the [00:12:45] clients would find that else we could potentially lose a client.

And so who ultimately suffered the losses? There was investors. So the big firms put these, these, uh, collateralized mortgage obligations into a fund, repackaged them, got the risk off their books to the [00:13:00] investors. And eventually, as an example, the Falcon Fund went to zero. Citigroup settled with the, with the clients for about 50 cents on the dollar.

Uh, otherwise the clients really lost everything. So this case serves as a cautionary tale. About the [00:13:15] risks associated with complex structured products known as private investments, especially when transparency is lacking and due diligence is overlooked. So what can we do now? What we, what we really need to do as investors, we need to focus on [00:13:30] our goals.

We shouldn't be swept up by the herd mentality or the pressure to follow what sounds like the next big thing. Remember, sometimes the word private just means they're dressing up a problem in a tuxedo. [00:13:45] So if you don't know what you're buying or can't explain it, um, or why you're being sold it, you should always take a step back.

That's the golden rule. So I'm now gonna leave you with my six pillars of successful investing. The first three are [00:14:00] principles or investors', attitudinal approaches to investing that occur in the mind of the investor rather than inside the portfolio. And those three principles are faith in the future, patience and discipline.

I'll [00:14:15] elaborate on this in a moment. The last three pillars are methods of managing the portfolio itself, and those are asset allocation, which is how we spread our cash among investments in either stocks or bonds. And then [00:14:30] there's diversification, which really relates to, to the extent we have either stocks or bonds, which bonds do we have in the bond portfolio to diversify it, and which stocks do we have in the stock portfolio to diversify it?

So there's allocation [00:14:45] stocks versus bonds. There's diversification, which stocks within the asset class stocks. And then there's rebalancing. When, when we have a target, let's say 70% target. Uh, a portfolio to stocks and stocks become, uh, 80% [00:15:00] we might want to rebalance, right? So, so we want to, we wanna steal from the rich and give to the poor.

We don't wanna let things grow disproportionately larger than their targets. So the first three principles are much more important because [00:15:15] principles dictate the practices in the sense that belief always dictates behavior. So the faith in the future, the patience and the discipline are most important.

So if we start with those [00:15:30] three foundational principles that shape our mindset as an investor, faith, patience, and discipline. Without faith in the future, it's almost impossible for one to succeed as a stock investor over the long haul. Because at every bump in the [00:15:45] road, they'll perceive it as the road ending, and they need to pull off and stop their journey.

If they don't have a faith in the future, they need an advisor or a behavioral investment counselor who can infuse the faith to them every time that it's needed. 'cause without that faith, they, [00:16:00] they won't succeed. The second is patience. So patience is about resisting the temptation to react to whatever is causing us to be afraid at the time, whether it's the pandemic.

Or whether it's a recession or whether it's a bear [00:16:15] market, it's okay to to feel afraid, but it's never okay to respond by reflecting that fear, by changing our investment program or our portfolio in response to it. So in short, patience is about never doing the [00:16:30] wrong thing in response to whatever's going on.

Discipline is different. Discipline means sticking with what's right, always. Throughout every challenge. So when the pandemic happened, for example, and the global economy, [00:16:45] uh, shut down for about a year. Discipline means if you were saving $10,000 a month into your portfolio stocks, you should continue to do that.

So discipline is continuing to do what's right. Patience is avoiding [00:17:00] doing what's wrong. Two different things. So faith. Patience and discipline are the three guiding principles that dictate behaviors. And we already talked about the three pillars that deal with portfolio construction, which again is asset [00:17:15] allocation, mix of stocks versus bonds, versus cash diversification within stocks or within bonds.

Which stocks or bonds do you have to diversify against the others? And then rebalancing, stealing from what's gotten expensive. Maybe the US markets [00:17:30] versus the international markets and putting into what's got, uh, relatively inexpensive and, and, and continuing to do that all the time as we wrap up. I want to remind everyone not to take everything at face value.

The democratization of private [00:17:45] investments, which everybody, even if they haven't read, will now begin to recognize what is written about. I see it every day on the news media or in the newsprint, and, and so the democratization of private investments sounds empowering. It's gonna give the small people [00:18:00] like us a chance to, to get involved where only the, the wealthiest used to be able to tread.

But it's worth questioning who really benefits from this. Stay curious, stay cautious and keep your eyes open. So with that, I want to thank you for tuning into today's [00:18:15] Fix of Friday. If you found it useful, um, please hit subscribe, share with your friends, and, uh, join me, uh, on the next fix of Friday as we keep tackling the myths and realities of the money world.

You can [00:18:30] get us on. Crazy Wealthy podcast.com. You can also get us on all the traditional venues like, uh, apple, Spotify, and wherever your favorite podcast shows are, are typically, um, your favorite listeners.[00:18:45] 

Voiceover: Thank you for tuning into another episode of The Crazy Wealthy Podcast. For more insights, resources, and to sign up for our newsletter, visit crazy wealthy podcast.com. Until [00:19:00] then, stay crazy wealthy.

Disclaimer: The previous podcast by Fusion Family Wealth, LLC Fusion was intended for general information purposes only. No portion of the podcast serves as the receipt of or is a substitute for personalized investment [00:19:15] advice from Fusion or any other investment professional of your choosing. Different types of investments involve varying degrees of risk, and it should not be assumed that future performance of any specific investment or investment strategy or any non-investment related or planning services, discussion or content will be profitable.

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To provide investment advisory services, a copy of Fusion's current written disclosure brochure discussing our advisory services and fees is available upon request or at www.fusionfamilywealth.com.