New Startup Offers Lending to the 401(k) for the 401(k)

A startup backed by hedge fund manager Bill Ackman and private equity billionaire Henry Kravis is banking on a new idea for retirement savings: The 401(k) should be treated like a mortgage.

Basic Capital offers 401(k) participants and IRA owners an option to use leverage, just not through options or futures on equity securities. Rather, the firm provides financing for four times what someone contributes to their account, “amplifying your market exposure and supercharging the compounding effect,” CEO Abdul Al-Asaad said last week in a LinkedIn post. It’s aimed at everyday folks who are starting to build wealth. One of the first clients, for example, is a family-owned plumber and electrician company. Another client, a warehousing provider, has also signed up. Its employees allocate 60% of contributions on average to the financing option.

“These workers are our chief focus, which is why we’re building partnerships with businesses whose employees typically don’t earn high salaries,” Al-Asaad said.

It Isn’t Free

The financing charge is currently 6.26%, as well as 5% of an account’s gains at the time of liquidation. Basic Capital charges 50 basis points for asset management, and IRAs have an additional $25 monthly subscription fee. The firm allocates 85% of a participant’s assets to a bond ETF, which helps pay for the financing, Bloomberg columnist Matt Levine recently wrote. The other 15% is invested in SPY, the SPDR S&P 500 ETF. Levine’s assessment of Basic Capital’s idea: “This is cool.” The company has played up that statement, linking to the column on its site. But Al-Asaad noted that the firm has no shortage of detractors and acknowledged that the service isn’t for everyone.

The service “may sound innovative, but it’s only relevant to a very narrow slice of the population,” labor economist Teresa Ghilarducci told ETF Upside. “And that slice of the population should not buy the product.” Rather, most workers need plain vanilla retirement investment options, as only about 7% of young employees earn more than $100,000, she said. “And even they would have to believe — against considerable uncertainty — that their returns will consistently exceed that cost of borrowing,” she said. While Basic Capital characterizes the service as a mortgage for retirement investing, she contested that notion, as mortgages provide the essential of housing in addition to potential capital gains. “This product may seem ‘cool’ for the investor, but it’s not. It’s cool for the company.”

Implementing that Innovation. There are some potential constraints in the smaller employer market. Jason Roberts, CEO of the Pension Resource Institute, pointed to a few:

• Smaller businesses often lack in-house expertise to help understand the service and benchmark fees and expenses.
• It could be problematic that participants, not fiduciaries, choose how much to contribute to the financed option. Having a cap on contributions could be useful to help deter class-action litigation.

“I’m always encouraged by innovation in the defined contribution space and I am excited to see the beginning of a trend towards the ‘democratization’ of products and investment strategies typically reserved for high-net-worth investors,” Roberts said. “It’s the way those products and strategies are delivered that makes all of the difference, however.”