The DOL’s proposed regulation on selecting investments, including alternative assets, 2026-06178.pdf, identifies six factors that should be considered in the process of selecting any investments for participant-directed plans, such as 401(k) plans and private sector 403(b) plans. The six factors are: Performance, Fees, Liquidity, Valuation, Performance Benchmark, and Complexity. The proposal describes each of those factors and provides 20 examples of their application.

In earlier posts, I covered four of the factors—Performance, Fees, Performance Benchmarks and Complexity, and their examples.

In my last three articles, Alternative Assets (22), Alternative Assets (23) and Alternative Assets (24), I looked at the Liquidity factor and the first two examples of the application of that factor.  This article looks at the third example:

(3) Example. Plan-level liquidity—

(i) Facts. Plan terminations, changes in plan recordkeepers or investment providers, and corporate sponsor mergers and acquisitions are examples of circumstances that may impose relatively short-term liquidity demands on a plan’s designated investment alternatives. This is especially true in the case of a designated investment alternative (such as a pooled investment vehicle) with a strategy involving a target position in certain private assets along with public assets (e.g., publicly traded securities). With such designated investment alternatives, a specific plan’s (or, in a pooled investment product, other plan’s or non-plan investors’) need for relatively short-term liquidity (e.g., when the investor wants to exit the investment) may present significant liquidity risk to the designated investment alternative as a whole such that it cannot maintain its asset allocation targets. Thus, in such circumstances, designated investment alternatives may or must impose temporal restrictions on redemptions (e.g., they might require advance notice and permit only incremental redemptions over a period of time). When fulfilling withdrawals, particularly large withdrawals, diversified designated investment alternatives may temporarily deviate from their target asset allocations. For example, a designated investment alternative that is designed to have a 90 percent allocation to fully liquid instruments may have to temporarily accept a lower allocation to fully liquid instruments to satisfy a large withdrawal.

(The bolding in this article is mine…just to emphasize the points that I consider the most important.)

Comment: This example illustrates a liquidity issue at the plan level.  A liquidity restriction may involve timing (e.g., a 12-month put or a queue for quarterly redemptions with a cap on the maximum redemption amount per quarter) or a reduction in value due to the redemption (e.g., a market value adjustment, MVA, or a contingent deferred sales charge, CDSC.  For our purposes, a liquidity restriction could be any limitation that could result in an impairment on daily trading…that would include a penalty, a cost or a timing restriction.

(ii) Analysis. Plan fiduciaries must give consideration to, and determine, that the scope and duration of redemption restrictions at the plan level meet the anticipated needs of the plan. This includes whether the designated investment alternative has a sufficient process in place to balance the plan’s potential need for withdrawal against the plan’s desire for the designated investment alternative to maintain smooth and consistent target positions, including following a significant withdrawal of investors other than the plan.

Comment: It seems obvious that fiduciaries must consider “scope” (e.g., market value adjustment) and “duration” (e.g., quarterly redemption, but with limits and a queue).  “Anticipated needs of the plan” might include changes of recordkeepers or removing an underperforming investment.  In the past, market value adjustments or puts related to stable value funds and resulting from a desire to change recordkeepers have frustrated plan sponsors and fiduciaries—even though they had contractually agreed to them. That is a consideration when investing in any investment that has liquidity restrictions.  However, it is legally permissible to invest in products with liquidity restrictions so long as an appropriate analysis is done.  That analysis requires an evaluation of the benefit provided by the restriction as compared to the burden imposed by the restriction.

The DOL’s conclusion below discusses two scenarios.  This post covers the first scenario; my next article will cover the second.

(iii) Conclusion. A plan fiduciary is deemed to have met the consideration and determination requirements of paragraph (i) of this section, and section 404(a)(1)(B) of ERISA, with respect to the plan-level liquidity needs of a given plan in connection with a given designated investment alternative (including one that holds a percentage of assets that are not securities, non- publicly traded securities, or securities acquired in exempt offerings) in either of the two following scenarios. (A) In the first scenario, the plan fiduciary evaluates, including, if appropriate, with the advice of a third-party investment advice fiduciary within the meaning of section 3(21)(A)(ii) of ERISA, in concert, the maximum that the designated investment alternative will allocate to illiquid investments, the time until such investments could likely be sold without reducing their value, the time until such investments will return capital to their investors, and the required advance notice plans must give before exiting the designated investment alternative. After this evaluation, the plan fiduciary concludes that the designated investment alternative will appropriately balance the future liquidity needs of the plan, the ability of the designated investment alternative to achieve increased risk-adjusted return on investment, and the ability to maintain its asset allocation targets even if there were redemptions from multiple plans or non-plan investors.

(B) In the second scenario… [covered in the next article]

Comment: The first scenario focuses on the review of these considerations:

• the maximum that the designated investment alternative will allocate to illiquid investments,
• the time until such investments could likely be sold without reducing their value,
• the required advance notice plans must give before exiting the designated investment alternative.

For example, a stable value fund will typically impose a market value adjustment that applies when interest rates increase and, as a result, the underlying portfolio, consisting primarily of bonds, has gone down in value. The market value adjustment is the difference between the guaranteed principal and the investments in the fund.  Fiduciaries would need to understand that and consider it relative to other options, e.g., money market funds.  The fiduciaries need to make a reasoned decision that the higher guaranteed rates justify the “burden” of a potential MVA (or possibly a put which would delay a change of recordkeepers).

A similar analysis would need to be done where a target date fund has an allocation to private funds, if the allocation causes a liquidity issue.

It strikes me that this analysis may be considered complex by plan fiduciaries.  If so, one course of action would be to use a 3(38) deciding investment advisor to do the analysis and make the decision.

The preamble discusses this example as follows:

Paragraph (i)(3) of the proposed regulation contains a positive example of how a plan fiduciary may be deemed to have appropriately considered the plan-level liquidity needs of the plan when selecting a designated investment alternative, including one that holds a portion of illiquid, non-publicly traded securities. Just as plan participants may want or need liquidity, retirement plans themselves may need to convert a designated investment alternative’s assets into cash without a reduction in value. For example, plans may terminate, merge, or the plan fiduciary may simply decide to liquidate the plan’s share in a designated investment alternative if the fiduciary decides to close out the position. Plan-level liquidity considerations also include whether the designated investment alternative manager has the ability to maintain asset allocation targets if other plans (or other investors) demand a redemption.

…..

Under the second path, plan fiduciaries may instead conduct an objective, thorough, and analytical evaluation, on their own or with the help of a third-party investment advice fiduciary, to assess whether a pooled investment is sufficiently liquid to offer as a designated investment alternative. The plan fiduciary should determine the time it would take a designated investment alternative to sell its illiquid investments in the quantity required by the plan’s liquidity needs without reducing their value and the liquidity restrictions the investment manager places on the designated investment alternative. The plan fiduciary must conclude that the designated investment alternative appropriately balances future liquidity needs with the ability of the designated investment alternative to achieve increased risk-adjusted return on investment net of fees and the ability to maintain its asset allocation targets even if the fund faces a significant pull on liquidity from redemption requests.

Comment: The preamble discussion basically affirms the scenario in the proposed rule.  As with the proposed rule, it makes clear that the DOL expects fiduciaries to consider the impact of redemptions by other plans on an investment’s allocations:

The plan fiduciary must conclude that the designated investment alternative appropriately balances future liquidity needs with the ability of the designated investment alternative to achieve increased risk-adjusted return on investment net of fees and the ability to maintain its asset allocation targets even if the fund faces a significant pull on liquidity from redemption requests.

In effect, the DOL is saying that fiduciaries need to consider whether redemptions by other plans—on funds that are not fully liquid—may cause the fund (e.g., a TDF) to vary from it’s intended allocations (and therefore possibly underperform). That is not a common practice today, at least in my experience.  I don’t think that most committee members are prepared to do (or knowledgeable about) that kind of analysis.

Concluding Thoughts

For the most part, the DOL’s guidance on analysis and conclusions makes sense.  It is essentially that fiduciaries need to understand the burdens of liquidity restrictions and the anticipated benefits, and to evaluate that information in order to make a decision in the best interests of the participants.

I think that the DOL’s opinion that fiduciaries should consider the impact of redemptions on contemplated investments (and particularly those with non-publicly traded assets) also makes sense.  However, I see that as a change from current practices.  I also see it as being a complex that most fiduciaries are not well-prepared to do.