You are too poor to invest in private equity

Even in the United States, the world’s leading exponent of capitalism, the so-called paternalistic function of the state is present and deeply rooted. So much so that it shapes individual choices even in the sector that, more than any other, serves capital: the financial market.

Being able to choose freely how to invest one’s financial surplus is apparently asking too much, even in the United States. Today, in fact, more than 98% of households are prohibited from investing directly in private equity and venture capital funds. These are deemed too risky for the average American household and its level of risk aversion. Individuals are therefore barred from exercising their own judgement and deciding which investments are or are not good for them.

Just another prohibition among many, one might think. The trouble is that this one has turned out to be particularly costly.

Looking at the historical data of private equity and venture capital funds and comparing them with the main stock indices, we find that from the 1990s to today the former have outperformed the latter by 3-4% on average.

Households that the American state considers sufficiently independent, namely those with an income above 300 thousand dollars, have meanwhile been able to enjoy the excess returns of this type of investment for all these years. This could add a further angle to the debate on economic inequality and its origins, but this is not the place for it.

A report by Voya Financial, a firm managing more than 222 billion dollars, highlights that these funds are better placed to reduce a portfolio’s overall risk thanks to diversification; so even a highly risk-averse household would actually benefit from the freedom to invest in them. As for riskiness, the report points out that over recent decades the volatility (the component that determines riskiness) of private equity funds has been significantly lower than that of the main stocks, thus contradicting the regulator’s judgement.

There are also further benefits for the economic system as a whole: private equity and venture capital have a much longer time horizon than traditional investments. This allows the capital invested to flow into the real economy and fund far-reaching projects capable of innovating the economic system. For capital to bear fruit, time is obviously needed, and this reduces the liquidity of the investment, that is, its convertibility into cash. We are talking about time horizons that can range from 3 to 7 years. Over such a span, and in this historical period, many things can happen, including a recession. These funds are highly exposed to one, since they invest in heavily indebted and therefore riskier companies.

Once again the individual is treated by the state as a helpless child, always in danger and lacking judgement. The freedom to allocate one’s financial surplus as one wishes gives way to the fear of making mistakes or being deceived. In this way the state creates no incentive to learn basic notions needed in everyday life; if anything, it encourages intellectual laziness.

Very often the paternalistic function is not seen to come with a price, since that price is often intangible. In this case it amounts to billions upon billions of dollars that American households could have earned on their savings and that instead went only to the wealthiest segment of the population. Indeed, not only are the individual households described above unable to access these funds directly, but so are “401(k)” funds, pension funds worth around 6 trillion dollars.