My last four  articles, Things I Worry About (15), Things I Worry About (16), Things I Worry About (17) and Things I Worry About (18), reviewed  the President’s August 7 Executive Order (EO) entitled Democratizing Access to Alternative Assets for 401(k) Investors (Democratizing Access to Alternative Assets for 401(K) Investors – The White House) and discussed DOL guidance from the first Trump administration about the selection of asset allocation investments with private fund allocations.

This article continues the discussion in my last article about the 2020 DOL Information Letter (06-03-2020.pdf)  and its discussion about the inclusion of an allocation to private equity in an asset allocation fund, such as a collective investment trust (CIT). That guidance is important today, since it will almost certainly be the foundation of the new guidance that the Executive Order directs the DOL to issue.

Picking up with where my last article left off, the Information Letter continued to say:

“It would also be important for the responsible fiduciary to consider the asset allocation fund with a private equity component in light of the plan’s features and participant profile (including, e.g., participant ages, normal retirement age, anticipated employee turnover, and contribution and withdrawal patterns) and make a considered decision about whether the characteristics of the investment alternative align with the plan’s characteristics and needs of plan participants, taking into account, among other things, the investment alternative’s investment allocation and strategy, fees and other expenses, and the nature and duration of any liquidity restrictions, the participants’ ability to access funds in their accounts (e.g., loans and distributions when employees separate from service with the sponsoring employer), and their ability to change investment selections on a potentially frequent basis.” [The bolding is added by me.]

Comment: This approach is similar to the DOL’s 2013 Tips on selecting target date funds (target-date-retirement-funds-erisa-plan-fiduciaries-tips.pdf):

“You should consider how well the TDF’s characteristics align with eligible employees’ ages and likely retirement dates. It also may be helpful for plan fiduciaries to discuss with their prospective TDF providers the possible significance of other characteristics of the participant population, such as participation in a traditional defined benefit pension plan offered by the employer, salary levels, turnover rates, contribution rates and withdrawal patterns.”

In effect, the DOL is saying that the allocations and strategies of an asset allocation vehicle, including one that holds alternative assets, should be appropriate and prudent for the covered workforce. Where the investment is in a CIT, the plan fiduciaries should ensure that the adviser and the trustee (as 3(38) investment managers) are giving consideration to those matters. Realistically, though, the CIT’s allocations will need to more generally be consistent with retirement investing for a large number of participants over many plans. In that case, while there isn’t any on-point guidance, I imagine that the analysis would be to make sure that the allocations and strategies of the allocation vehicle weren’t inconsistent with the demographics of the covered workforce, e.g., an aggressive allocation strategy where the circumstances suggested a conservative approach.

Where the allocation to alternative assets is through a participant managed account, the issue will be for the account allocations to be based on the needs and circumstances of the particular participant. In this case, the investment manager for the participant account should gather sufficient information about the participant’s investment profile to make that determination.

The considerations for mutual funds are similar to CITs except that mutual funds will have investors who are not in retirement plans and who may have other objectives. That places an additional responsibility on plan fiduciaries to evaluate whether the asset allocations and glide paths are appropriate for the participants in the particular plan.

The Information Letter continues to say:

“Additionally, as with any designated investment alternative, the plan fiduciary must consider whether it has the skills, knowledge, and experience to make the required determinations or whether the plan fiduciary needs to seek assistance from a qualified investment adviser or other investment professional.” 

Comment:  Nothing new here. This theme—if fiduciaries don’t have the expertise, they need to hire it—is repeated throughout the ERISA world…in court decisions, DOL guidance, and literature about fiduciary responsibilities.

The Information Letter continues:

“The fiduciary also must periodically review whether the investment vehicle continues to be prudent and in the best interests of plan participants, taking into account the considerations outlined above and any other factors that the plan fiduciary deems appropriate in light of its fiduciary duties under ERISA.”

Comment: Nothing new here either. There is a fiduciary duty to monitor investments and service providers. A common part of monitoring is the compare performance to similarly designed investment vehicles. That may, at least initially, be a challenge for funds with significant allocations to private funds (and other alternative assets).

The Information Letter then goes on to explain:

“The fiduciary must also determine whether plan participants will be furnished adequate information regarding the character and risks of the investment alternative to enable them to make an informed assessment regarding making or continuing an investment in the fund. This factor would be especially important in the case of a plan or responsible plan fiduciary claiming limited fiduciary liability under ERISA section 404(c) for participants exercising control over their accounts (see 29 CFR 2550.404c-1) and/or deciding that a particular investment alternative would be prudent to use as a qualified default investment alternative (QDIA) for the plan under 29 CFR 2550.404c-5.”

Comment: In effect, these statements point out the need for fiduciaries to obtain information about the asset allocation vehicles needed (i) to satisfy the participant investment disclosure requirements under 404a-5; (ii) to obtain the fiduciary protections of 404(c) (which includes the 404a-5 disclosures); and (iii) to obtain the fiduciary protection of the QDIA regulation—404c-5—for investing the accounts of defaulting participants. That information may be more difficult to obtain for alternative investments; however, investment providers and recordkeepers will likely help to solve that problem. Nonetheless, plan fiduciaries should ensure that appropriate disclosures are being made to participants.

The Information Letter then concludes:

“In conclusion, a plan fiduciary would not, in the view of the Department, violate the fiduciary’s duties under section 403 and 404 of ERISA solely because the fiduciary offers a professionally managed asset allocation fund with a private equity component as a designated investment alternative for an ERISA covered individual account plan in the manner described in this letter.”

Comment: This is the part of the Information Letter that received the most publicity when it was issued. Unfortunately, some parties marketed this as if the DOL had explicitly approved of including private equity in 401(k) plans. That was not the case. First, the Information Letter only discussed the inclusion of private equity in asset allocation funds in 401(k) plans. The DOL’s letter explicitly said that it was not talking about standalone private equity investments. Second, the conclusion said, in effect, that ERISA does not prohibit any investment; instead, it places the burden on fiduciaries to determine if they are prudent for retirement investing by the covered workers. Fiduciaries need to determine if the use of alternative investments is appropriate and prudent and whether the managers of the asset allocation vehicles are competent to prudently determine the allocations and then select the investments to populate the allocations.

Concluding Thoughts

We are in the early stages of the process for adding alternative assets to asset allocation funds for participants. The next step is for the DOL to issue guidance to help fiduciaries with that process. I expect that this will gradually gain momentum, which will be accelerated by the DOL’s guidance. The big question, though, is:  Will the largest target date fund managers add alternative assets to their funds?

Stayed tuned. There is more to come.

The material contained in this communication is informational, general in nature and does not constitute legal advice. The material contained in this communication should not be relied upon or used without consulting a lawyer to consider your specific circumstances. This communication was published on the date specified and may not include any changes in the topics, laws, rules or regulations covered. Receipt of this communication does not establish an attorney-client relationship. In some jurisdictions, this communication may be considered attorney advertising.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Faegre Drinker.