The third excuse is that alternatives aren’t liquid enough, something target-date funds need them to be. But these funds can still offer liquidity with alternative investments in their portfolios—in a variety of ways. For example, they can maintain a cash buffer or include assets with higher liquidity profiles.
At this point, you might console yourself and think, “Well, at least I’m in the same boat as other individual investors. If institutions can invest in these assets and individuals can’t, maybe that makes sense. Besides, I’m no worse off than the other guy.”
Except that’s not true. When the other guys are wealthy—“accredited” or “qualified” investors—they’re allowed to invest in alternative assets while you aren’t.
The two real reasons employers don’t adopt alternatives in 401(k) and other DC plans is because of the supposed complexity and fees.
If you are reading closely, you will think, "Didn't he just say complexity is not an appropriate reason?” We’re talking about something different here: the pension and benefits departments and record-keepers at DC plans are busy. This topic requires extra work for them, and it can indeed be complex. Besides, there’s no outcry from employees asking for the new assets.
That’s no excuse, of course. The plan sponsor is a fiduciary and owes the worker a prudent person standard of care. That includes, among other things, a duty to diversify investments. It is widely known that alternatives can help with that and meet the prudent person standard. It is time for employees to insist on this kind of diversification, for advisors and consultants to promote it, and for employers and target-date fund managers to provide it.
The question of fees is a legitimate issue. Costs and fees are always important, and alternative assets often do charge higher ones than other investments. But the real question to ask is about the value provided after fees. As we discussed before, the diversification these assets can provide can be very powerful. The general rule is that fees must be reasonable. And that can be taken care of with an appropriately limited allocation to alternative assets that’s blended with more traditional assets to create a target-date allocation—and with total expenses that are reasonable for an ERISA plan.
So if you think your 401(k) should be allowed to use alternative investments and you don’t want to look for a job at one of the rare plan sponsors that do offer these options, then call your benefits department and tell them you want them to meet the prudent person and diversification standards of ERISA and to provide a target-date fund with exposure to these important investment classes.
And if you are an advisor, remind your plan sponsor clients that this is prudent person fiduciary activity.
Charles E.F. Millard is the former Director of the U.S. Pension Benefit Guaranty Corporation.