Alternatives in 401(k): Fiduciary Duties First

The recent executive order by the White House to open the door to alternatives in 401(k) plans is seen as a boon to asset classes like private equity, private credit, and private real estate. Private market assets, like private equity and credit, provide exposure to a larger investible market—only an estimated 1% US companies are publicly traded—so alternatives may provide 401(k) participants access to similar investment opportunities of other fiduciary-managed plans like larger pension funds and cash balance plans.¹ Privates may also potentially offer excess return per unit of risk and an ability to steadily compound returns over longer periods of time. While private market assets are considered “riskier” than the public markets assets, parts of the private credit market, like senior secured direct lending, may offer investors equity-like returns with less risk than stocks, which may have applications in managed solutions like target date funds and public/private-blended strategies.

However, not all alternative assets or strategies are created equal. Asset classes like cryptocurrencies and commodities, or alternative investment strategies like long-short equity or hedge funds, which are not widely available in retirement plans of any type, must be evaluated by plan sponsors and their advisors for suitability.

While alternatives do offer potential opportunities, the Employee Retirement Income Security Act (ERISA) of 1974 requires employers of defined benefit contribution plans to always act in their employees’ best interests. Therefore, it is incumbent upon plan sponsors, consultants and financial professionals to reexamine criteria about suitable investments within their plans and then thoroughly evaluate the specific risks, like leverage, complexity, lack of transparency, higher fees and, in some instances, lack of liquidity, of each type of alternative investment. This process should enable the fiduciaries to make sound decisions when selecting strategies that may be additive and appropriate for plan participants.