President Donald Trump recently issued an executive order directing the Labor Department to look into the implications of allowing sponsors of 401(k) plans and other defined contribution plans to offer access to alternative investments to plan participants. According to Trump’s order, alternatives include:
- Direct and indirect holdings in real estate, including debt-related instruments
- Actively managed vehicles holding cryptocurrencies or other digital assets
- Direct and indirect investments in commodities
- Private equity, private credit and related holdings
- Lifetime investment strategies, including longevity risk-sharing pools
If this does move forward, it will have implications for both retirement plan participants and retirement plan sponsors. Here are some things to consider in advising these clients.
Implications for 401(k) Participants
For clients who are participants in a 401(k) plan or other DC plans that see alternatives added to their investment menu, it's important to review the updated plan lineup. You can then advise them if any of the alternative offerings are appropriate for their plan account.
If their portfolio allocation includes alternatives in other accounts, such as taxable accounts or an individual retirement account, there is likely no need to invest in the alternatives offered in their 401(k) plan. If after reviewing new offerings you feel that allocating a portion of a client’s 401(k) account to an alternative might be a good idea, you will want to be sure that you fully understand the expense ratio or other expenses associated with this investment and any liquidity issues that may be associated with it.
In some cases, the full extent of the fees and expenses associated with some alternatives can be difficult to quantify due to a lack of transparency.
Liquidity can be a tricky and confusing issue for both clients and advisors. On one hand, a 401(k) or similar retirement plan account is generally considered a long-term investment. The time frame can vary based on clients’ age, whether they stay with their current employer long term and a host of other factors. Even though the account holdings may not be traded on a daily basis, liquidity is still important.
One factor regarding liquidity is the need to periodically rebalance a portfolio within a retirement plan account. Generally, clients would simply transfer assets between holdings to rebalance based upon an advisor’s instructions. If an alternative investment has a lack of longevity, this can make rebalancing a bit more difficult.
Another liquidity issue surrounds what happens if clients leave a company. If the choice is to roll their 401(k) or other account balance to an IRA, would all of the money invested in an alternative plan option be readily available? Would these funds be held up for a period of time before they could be rolled over?
Implications for Plan Sponsor-Clients
For plan sponsor-clients, there are many implications to providing access to alternative investments. Plan sponsors, of course, have direct fiduciary responsibility regarding virtually all aspects of the plan they offer to their employees. This includes investment selection, and with a traditional menu of mutual funds, this fiduciary responsibility might include:
- Reviewing the funds’ performance relative to peers
- The funds’ expense ratios
- The asset classes covered in the fund menu
- Any bundled investment options such as target date funds
It is incumbent on plan advisors to work through how to proceed with the plan’s executive committee. Does it make sense for the plan to expand its offerings in the alternative space? And if so, what types of alternative assets should it offer?.
An alternative asset offered through a standard fund format like a mutual fund or, with sufficient liquidity and transparency, an exchange-traded fund could be a prudent choice. But more traditional private equity investments and similarly structured alternatives could pose a liquidity issue — for participants who need to take a hardship withdrawal, for example.
If the plan sponsor’s executive committee seems to be leaning toward offering this type of investment, you will want to have a serious discussion with committee members to understand their motivations.
It could be that this is a relatively small company and one or more senior executives has a specific idea of the types of alternative investments they want access to for their own 401(k) accounts. That’s fine, but as advisor to the plan and as a plan fiduciary, your responsibility is to all participants. You may find yourself having to remind plan sponsors that they are a fiduciary as well and that their focus needs to be on what is best for all participants..
Another issue is educating the plan’s participants regarding alternatives. That would include what these investments are, how they work and how they compare to more traditional investment styles such as stock and bond funds.
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