Alternative Investments in Retirement Accounts (Part I)

A recent White House Executive Order would “Democra(tize) Access to Alternative Assets for 401(k) Investors.”  

The administration’s stated goal is to “enable broader portfolio diversification, potentially enhance retirement returns, and modernize investment options for over 90 million Americans in defined-contribution plans.” The Order’s opening (and most often cited) premise and rationale: “the vast majority of these investors do not have the opportunity to participate, either directly or through their retirement plans, in the potential growth and diversification opportunities associated with alternative asset investments.”

But Here is the Deal – most of the assets covered in the Executive Order (private market investments, real estate, digital assets, commodities, infrastructure development, and longevity pools) can already be held, either directly or indirectly, in Defined Contribution plans, 401k plans included. All of the alternatives can be held in non-exempt portfolios.  

And Yet - alternatives are seldom included in retail (individual) investment accounts, and only incidentally in many managed and institutional accounts. Why?

Long story short,

1. Plan sponsors and fiduciaries[1] are often reluctant (or even afraid) to include alternatives in the investment choices they offer.

2. Account owners often view alternatives as confusing, slightly murky, dodges for the ultra-rich – even while they wish they could reap the higher returns alternatives may provide.

There are some very real justifications for the Sponsors’ and  Fiduciaries’ fears. Account Holder’s attitudes are less justified but certainly dampen their enthusiasm for alternatives.

We talk about sponsors and fiduciaries’ fears (real and imagined) here and in some subsequent installments. We’ll look at account owners’ attitudes in the light (if any) we shed on sponsors and fiduciaries.

Sponsor and Fiduciary Challenges:

When they offer alternative investments in retirement plans, plan fiduciaries and sponsors confront expanded regulatory, operational, legal, and educational challenges. In effect, adding alternatives to the plan’s options expands sponsor and fiduciary roles to not only their ethical and ERISA duties to the plan and its participants, but to the alternative investments themselves.

Alternatives create legal, operational, educational, and compliance risks and impose obligations to prudently and safely offer the alternatives themselves in the retirement plan, balancing their potential benefits with heightened challenges.

When offering alternatives, wise Sponsors and Fiduciaries:

• Diligence and Prudence: investigate and monitor alternatives’ fees, liquidity, risk, and suitability for participants.

• Investment Policy: revise investment policy statements and committees’ charters to reflect the complexities of alternatives and enhance governance.

• Education: create tailored, ongoing education and transparent disclosures that explain the risks, costs, or liquidity constraints of alternatives compared to traditional investments.

• Disclosure: provide clear and comprehensive information about the unique risks, expected returns, and structure of each alternative offer.

• Liquidity: design the plan to meet participant withdrawal demands or to provide periodic liquidity.

• Valuation and Custody: thoroughly explain appraisal assumptions for hard-to-value assets.

• Fee Transparency: rigorously benchmark and justify fees – and transparently disclose them to participants.

Thus, alternatives spread a layer of fiduciary responsibility on top of the responsibilities sponsors and fiduciaries have for the non-alternative managed investments of your client base. The alternative (lol) to taking on those responsibilities is:

Litigation Exposure: Alternatives often prompt lawsuits if participants lose money or claim inadequate disclosures. Wise fiduciaries document all decisions and ensure compliance with ERISA and DOL guidance.

Recent litigation has involved predominantly private equity or crypto disagreements.

The most common subjects of litigation have been fees and fee transparency, the selection (depth and breadth) of alternatives, their suitability for investors, representative’s failure to monitor them, and the raw fact of their performance. We discuss these, and how to mitigate them, in our next installment.

Cambyses Financial Advisors  offers Portfolio, Asset, and Wealth Management and Planning services, for Businesses, their Retirement Plans, and their Owner’s Succession and Retirement. For more information, contact us at : +1 (818) 489-4228 or steven@cambysesadvisors.com

The information in this article has been included in good faith for general information purposes only. It is not intended to amount to advice on which you should rely, and we give no representation, warranty or guarantee, whether express or implied as to its accuracy or completeness. You must obtain professional or specialist advice before taking, or refraining from, any action on the basis of the content on our articles.

[1] Plan sponsors and fiduciaries, including Registered Investment Advisors and their Investment Advisor Representative if they act in those capacities, are legally and ethically responsible for managing retirement assets and administering them solely for the benefit of plan participants, following rules established by ERISA and related regulations.

A plan sponsor is the person or entity, most often the employer, that establishes and maintains the retirement plan for its employees. The sponsor takes on both business and fiduciary decision-making responsibilities under ERISA.

The plan fiduciary is any individual or entity that exercises discretionary control or authority over a plan's management or assets, including the plan sponsor, members of a plan committee, trustees, or appointed managers. The plan sponsor may be the fiduciary by default, but fiduciary responsibility can also be delegated, in whole or part, to other parties. Cambyses generally acts as a plan fiduciary in connection with our client’s plans.