My prior posts completed the discussion of the four Factors in the DOL’s proposed regulation that apply to most investments in participant-directed private sector plans. This article turns to the first of the two Factors that are specifically designed to address illiquid and hard-to-value investments, such as private funds. The Factor discussed in this article is Liquidity. After the Liquidity articles, I will turn to the Valuation Factor.

As background, 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 the proposal, the DOL described the Liquidity Factor and the associated fiduciary requirements as:

(i) Liquidity. The fiduciary must appropriately consider and determine that the designated investment alternative will have sufficient liquidity to meet the anticipated needs of the plan at both the plan and individual levels. For example, because participant-directed individual account plans are long-term retirement savings vehicles, particularly for participants early in their careers, there is no requirement that a fiduciary select only fully liquid products. Indeed, a prudent fiduciary process may regularly lead to a decision to sacrifice some plan- or individual-level liquidity, or both, in pursuit of additional risk-adjusted return.

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

Comment: Interestingly, and in my view appropriately, the DOL points out that there are two separate Liquidity considerations—Liquidity for participants and Liquidity for the plan.

Participant-level liquidity would be, for example, the ability of participants to do daily trading.  I suspect that plan sponsors will decide that daily trading is a must and that, therefore, they won’t select any investments that do not provide for daily trading.  (Of course, daily trading requires that valuations are appropriate for selling and buying an investment on any given day, but the Valuation Factor is for a future article.) In theory, though, fiduciaries could select investments that restrict participant trading, e.g., to quarterly transactions if the benefit, e.g., superior returns, was enough to justify the trading restrictions.

Plan-level liquidity is a different issue. An example of plan-level liquidity would be a restriction that provides that a plan could only eliminate an investment option on a quarterly basis, or an annual basis, or on a limited basis, e.g., where a private fund would only repurchase a limited number of interests each period.  To some extent, we already have investments with liquidity restrictions. Think in terms of stable value collective trusts where a market value adjustment may be imposed if the fund is removed from a plan.  That is a liquidity restriction.  And think in terms of general account guaranteed income funds where there may be a surrender charge or a 12-month put.  In all of those cases, it is generally accepted that the restriction is justified by the enhanced returns it affords.

The key is that there should be value to the participants that justifies the liquidity restriction.

Based on my experience in working with plans for several decades, though, I am concerned that fiduciaries often regret their initial decisions when they later decide to remove those investments from their plans.

From a more practical perspective, I think that the future of private funds in participant-directed plans will be with allocations in target date funds.  Those target date funds will almost certainly provide for daily trading for participants (and have supporting valuation methodologies).  Similarly, if the TDF suites have substantial assets, they should be able to provide plan-level liquidity as well—that is, allow for the removal of the TDF suite on reasonably short notice, say 60 or 90 days.

The preamble discusses this Factor as follows:

7. Liquidity

7.1. The Standard

Paragraph (i) of the proposed regulation clarifies that a fiduciary must appropriately consider and determine that the designated investment alternative will have sufficient liquidity to meet the anticipated needs of the plan at both the plan and individual levels. Alternative asset investments are often less liquid than the publicly traded stock and bond funds that are held by funds that plan fiduciaries often make available to plan participants. Illiquid investments generally offer an illiquidity premium to investors who are willing to hold their investment, for some time, without selling it for cash. Many retirement savers, particularly younger workers, have long investment time horizons until retirement and, therefore, fit the profile of an investor who can benefit from a liquidity premium. To achieve the goal of clarifying that ERISA gives fiduciaries the discretion to offer designated investment alternatives that contain illiquid alternative investments, the regulation also provides that plans do not need to offer fully liquid investment options. Nonetheless, plan fiduciaries must ensure that investments can deliver on any promises of liquidity that are made to participants and beneficiaries. Plan fiduciaries should also consider the liquidity needs of their plan and whether other plans’ (or other investors’) redemptions might adversely affect the liquidity of the designated investment alternative.

Comment: This discussion in the preamble adds some interesting DOL perspectives.  First, the DOL points out that plans make “promises” of a certain level of liquidity to participants and need to make sure that their plans can deliver on those promises. In other words, plan fiduciaries who select investments with liquidity restrictions should clearly communicate those restrictions to the participants.

That obviously applies to trading restrictions, but what about plan-level restrictions.  In the past—at least in my experience, fiduciaries have not communicated with participants about plan-level restrictions such as market value adjustments, contingent deferred sales charges, or requirements for puts. It isn’t clear if the DOL is referring to those types of plan-level restrictions; however, a conservative approach would be to communicate those restrictions as well–because they could potentially impact the value of investments made by participants.

Second, the DOL points out that fiduciaries need to consider whether, in selecting illiquid investments (or allocations within investments), redemptions by the plan or by other plans could affect the liquidity of the investment.  Taking that a step further, I believe that fiduciaries should consider any and all potential material effects of redemptions by the plan or other plans.  In that regard, there is a greater risk for investments with a few large holders or investments with a limited amount of assets. Those are types of considerations that fiduciaries should take into account.

Finally, the preamble discussion restates the proposition that ERISA does not limit fiduciaries and participant-directed plans to fully liquid investments.  Instead, fiduciaries need to evaluate the impact of any liquidity restrictions and decide whether there is offsetting value that justifies the investment.

Concluding Thoughts

I think the DOL got this right.  Now it is up to plan fiduciaries to determine whether or not to invest in illiquid or partially liquid investments, or investments with allocations to illiquid funds.

While there isn’t any requirement to add illiquid investments (or allocations) to plan lineups, there also isn’t a per se limitation.  Instead, fiduciaries need to evaluate the impact of the liquidity restrictions at both a participant and a plan level and decide whether or not there is an offsetting benefit for the participants. In most cases, that will require the assistance of an experienced retirement plan advisor.  This goes beyond the decision-making processes and information used for selecting traditional fully liquid investments such as mutual funds.

My next few articles will look at the DOL’s examples for the application of the Liquidity Factor.