INTERVIEW: Investors Unaware About The Role Of Alts In Retirement Accounts - PENSCO

Eliane Chavagnon

29 October 2013

The past three years has seen “very significant” amounts of money moving out of 401(k)s into individual retirement accounts, but many investors are unaware they can put private equity, private stock and real estate into a retirement account, according to chief executive, Kelly Rodriques.

The insights came as a surprise at a time when large institutional investors, such as pension funds and endowments, have been urged to look at the "Yale Model" of investing, in which private equity plays a prominent asset allocation role.

Indeed, holding high potential investments in a retirement account is one of the best ways to build wealth and/or generate income, Rodriques said.

Because most of the people who have rolled over into IRAs were previously in company-defined plans, there is a “fundamental lack of knowledge about one’s ability to direct investments with retirement money into asset classes other than mutual funds,” he told Family Wealth Report.

Even in the Bay Area - an area rife with entrepreneurs and investors who are familiar with a range of alternative asset classes - Rodriques estimates that “less than one in five know you can do this.”

He noted that while IRAs have grown from $3.5 trillion in 2009 to almost $6 trillion this year, 401(k)s have stayed the same or gone down.

“The perception is more control, more flexibility and less dependency on company-sponsored plans,” Rodriques said. “The returns on 401(k)s have been so poor.”

RIAs turning to alts

Rodriques said he has observed over the last five years that RIAs have intensified their focus on alternatives - particularly the asset classes of real estate, private equity and direct investments in companies. (PENSCO deals specifically with non-exchange traded alts in retirement accounts.)

He added that the emergence of the RIA and of a model where financial advisors moved out of large wirehouses has ushered in a broader level of independence as regards these asset classes.

“There is no doubt that part of what drives our business is an expansion of IRAs from 401(k)s,” he said.

After-tax focus

Also of note, Rodriques believes that advisors - particularly RIAs - are becoming increasingly sensitive about after-tax return.

“The AuM model is based on after-tax returns; you’re not charging someone their portfolio value before they have paid their taxes. This is a direct motivator to have advisors look at after-tax returns. Because of that, investing Roth or IRA money in these asset classes - where there are acceptable but not outsized returns - is beneficial for both the advisor and client,” he said.

In the case of the Roth IRA, some taxes are paid upfront, but then returns will be tax-free or tax deferred.

“The most common question or drawback is ‘how well does this investment need to perform in order to justify paying the tax upfront’?” Rodriques said.

“Many of our clients expect a better-than-average return from their alternative investment – and yes there is risk - but they wouldn’t be here in the first place if they didn’t think that the investment was going to outperform some of their liquid, traded investments.”

As highlighted previously by Rodriques, with increasing federal and state taxes on individuals, it makes “more sense than ever” to make a private equity transaction from funds in an IRA.