Who should decide whether retirement plans can include private investments like private equity, credit, hedge funds or direct real estate — and how should they be evaluated? In this episode we break down the DOL’s proposed rule, what makes alternatives different (costs, opacity, liquidity, valuation and risk), and why ERISA fiduciaries face special legal challenges when considering these options for DC plans. Learn what plan sponsors should document, how advisors should respond to marketing pressure, and what participants can do if they want to avoid alternatives in their lineup.
Jeffrey Snyder, Broadcast Retirement Network
Knut, it’s so great to see you. Thanks for joining us in the program this morning. Great to be here, I appreciate it.
Yeah, and I don’t wanna out you, but I’m gonna out myself. I’m a retirement nerd. I love ERISA.
I love all the things we do in our industry because we’re trying to help other people. But you are part of the Institute for the Fiduciary Standard. I wonder, before we get into alternatives and defined contribution plans, can you tell us a little bit about the Institute, what it stands for, what you do?
Knut A. Rostad, The Institute for the Fiduciary Standard
Absolutely. We are completing our 15th year, and we were formed because a group of advisors believed that there should be an entity, a legal entity that exists for no other reason than to further advocacy and education around what it means to be a fiduciary. And that’s what we’ve tried to do for the last 15 years.
And so we are a single issue group, and this is the only issue that we engage in. So suffice to say you love ERISA then. It is fantastic, yes.
And in that line, one of our board members is Phyllis Borzy, who of course lived ERISA for her whole professional career. And I’m honored that she’s been willing to join our board and help with our efforts.
Jeffrey Snyder, Broadcast Retirement Network
Yeah, well, very important. I wanna segue, the Department of Labor recently issued a proposed rule. And I think that the press maybe got it a little bit wrong.
I’m not a media guy, but I mean, they really framed it around alternative investments. But it really was to establish a better process, I think to select overall investments in the retirement plan. Let’s start with that.
Knut A. Rostad, The Institute for the Fiduciary Standard
I think what you say is, I’ll say it’s technically correct, but I’ll say that spiritually, I don’t think it’s correct at all because their reason for the rule as introduced a year ago by the executive order from the President of the United States was to make it easier for plan sponsors to recommend alternative investments. Anyway, so that’s how I’m viewing it. I think that’s how a lot of people in the ERISA world are also viewing it.
Jeffrey Snyder, Broadcast Retirement Network
Okay, so fair enough, I stand corrected. And there’s been, you read the popular press again, it’s all about Alts and DC, Alts and DC. So when we think of Alts, we’re talking just to kind of level set, we’re talking about private equity, private credit, hedge funds, real estate, direct real estate.
What is it about that, those types of investments that maybe differ from mutual funds, collective investment trusts, or do they differ?
Knut A. Rostad, The Institute for the Fiduciary Standard
Well, yes, in key aspects that directly impact whether someone is able to provide a fiduciary level evaluation. And as you perfectly well know, well, I don’t wanna put a thought in your head, but four or five of those key aspects have to do with costs, have to do with opacity, have to do with liquidity, have to do with ability to evaluate and value the vehicle. And then of course, that all comes down to risk.
And the bottom line is that we are very accustomed to having the key information about a vehicle, about an investment at our fingertips in the public markets. And most investors, most individual investors are not accustomed to getting partial information at best. And so that is what differentiates alternatives, i.e. those that live in the private marketplace as opposed to the public marketplace.
Jeffrey Snyder, Broadcast Retirement Network
So just to kind of follow up on, let me go down the stream of thought and I’m not presupposing anything, I don’t wanna play the devil’s advocate. I just wanna ask you, so obviously I can see why alternative managers will wanna be in this space. I mean, there’s trillions of dollars, there’s opportunity and we’ve covered that before, but the argument is that pension plans, state pension plans, corporate pension plans have allocations to these investment classes, these alternative investment classes.
Does that hold up in a defined contribution structure and if it does or does not, where would it fit into a DC, a 401k, a 403b, a 457b government plan?
Knut A. Rostad, The Institute for the Fiduciary Standard
That’s a really good question. And here to me, there is a differentiation that I have not seen made in the public discussion over the last month that this rule has been out there. But just to go back a half a step first, what is a risk is supposed to do?
And you know the answer to this, but just to put it on the record, it’s to protect the interests of participants in employee benefit plans and their beneficiaries, period, as you full well know. And how is this supposed to happen? Through standards of conduct and responsibility that of a fiduciary, which means, and again, this is not anything new, prudent, loyal, and diversifying and transparent management of retirement assets.
That is the crux of it right there. And so it’s important to keep in mind what is required of a plan fiduciary in order to fulfill this obligation. And what I’ve called a threshold issue is that because of the opacity, by itself, but when combined with the issues of liquidity, the issues of complexity, the issues of cost, the bottom line is that it is not possible for a plan fiduciary to make a fiduciary evaluation, to do the investigation that is required by a plan fiduciary under ERISA.
So that to me is the threshold issue that says from a point of view of plan sponsor, it should be a matter of, we are not in a position to be able to make these valuations, so we should stay away from. Now, what is not discussed to, and this gets back to your question, I think is that is a totally different situation than Mr. and Mrs. Smith sitting down with their personal financial planner who knows everything about the Smiths and knows about their retirement goals. And is then able to say, Mr. and Mrs. Smith, these alternative investments, whatever we’re talking about are more risky, are more complex, are more costly. However, if you wanna take 2% of your portfolio and put it in there, I’m not going to resign the account on that basis. But as you know, that’s a totally different scenario. So it’s not a matter of, should a financial advisor never talk about alternatives with their clients?
No, but in the context of ERISA and a plan sponsor, there’s a prima facie basis for saying that he or she is not able to do what he or she has to do as a fiduciary.
Jeffrey Snyder, Broadcast Retirement Network
Stop. So let me, if I may just jump in, let me ask you this question. So you talk about the responsibility of the fiduciary.
Oftentimes they will delegate to, they don’t lose their fiduciary responsibility, they’ll delegate to a retirement plan advisor, right? So they’ll hire someone that’s a 321 or 338. Obviously, you read the same press I do.
There’s a lot of trade publications, a lot of marketing. There’s going to be a deluge of people calling on plans sponsors and saying, hey, I’m from XYZ company, you should talk about this. Or advisors, what do you tell people that are going to be deluged by the marketing, by the sales, by the information that’s flowing to them?
How do you process it? And then how do you use your retirement plan advisor if you have one to sort through this information? Can you?
Knut A. Rostad, The Institute for the Fiduciary Standard
Well, I guess the first sort of basic point I would make is don’t do anything differently than you’ve been doing for five, 10 or 25 years before. And in most cases, and I think you may agree with this generalization, financial advisors have stayed away from alternatives because of the extra risk involved. Now, so I have not seen the case to all of a sudden sweep away the rationale and the experience and the views about alternatives just because the White House decided last year that it wanted to promote alternatives.
So that’s where I start from. But then, as I said before, if on a case-by-case basis, the retirement couple are dead set on putting something in alternatives because for whatever reason, then under those very specific circumstances and everything well-documented from the advisor’s point of view, I guess that to me is the way that it should be done if it’s done at all.
Jeffrey Snyder, Broadcast Retirement Network
Look, process in our business, and you know this better than I do, process is everything, following the right process, documenting is always the right approach. Let me close out by asking, we may have people watching the show that are participants, okay? And they’re seeing, there’s all sorts, again, you read the same press I do.
There’s a little bit of hysteria, a little bit of crisis baked into these articles. But what do you do if you see this and you don’t want, or you wanna voice a concern or an opinion to the fiduciary? I mean, what do you do from that perspective?
Knut A. Rostad, The Institute for the Fiduciary Standard
I think you reach out to your planned fiduciary and say that you wanna stay away from this. And if you can’t, if the planned fiduciary cannot reasonably guarantee that they can stay away from it, because again, as you know as well, sometimes, well, maybe more than sometimes, it’s extremely difficult to dig through all this and figure out what the heck is inside the wrapper, is inside the packaging, et cetera, et cetera, such as the Wall Street Journal article, which I was focusing on was saying. And if the planned sponsor cannot make that a reasonable affirmation that there’s not gonna be any alternative there, I would think that they would, that those planned participants should do what they need to do to ensure that they don’t have them in there, so.
Jeffrey Snyder, Broadcast Retirement Network
Yeah, I mean, do you remember, I remember kind of coming up in the 90s and back then there was, before consolidation of the investment lineups, they were like, this was the go-go 90s or late 90s with like tech funds and no valuations, et cetera. And they were adding funds left and right. And then you would always get someone later on when we started consolidating, you would get a group of participants said, I want a gold fund, or I want this.
And then they would open a self-directed brokerage window to have access. Do you think that that is a relief valve potentially? So as a planned sponsor, and I’m not saying you don’t have fiduciary responsibility, but you can provide a mutual fund window, for lack of a better term, a brokerage.
And maybe that’s a way to access these things if you know the risk and you’re willing to do that. I don’t know if that’s possible technologically, but it seemed to me that that is a potential relief valve for this type of issue.
Knut A. Rostad, The Institute for the Fiduciary Standard
I think that’s a really good question. And I hate to say this, but I don’t have a good answer for you. Not so much from a technical point of view, because I imagine that’s possible, but from the legal liability of a plan sponsor, which is front and center for these plans.
Jeffrey Snyder, Broadcast Retirement Network
Well, I think, not to cut you off, but I do have to run. And this is not an issue that we will solve on day one. I think we’ll have to bring you back.
But I think that, we’ve been down this road before in the industry in terms of accessing different types of asset classes. This has been a way to kind of take the pressure off, so to speak. I don’t, I’m not an attorney, so I don’t know the legal aspects of this, but my understanding is that less than 5% of people in a retirement plan, in general, will use the self-directed brokerage window.
It’s usually for the people who kind of rattle the biggest saber. Knut, we’re going to have to leave it there. Thanks for all your work at the Institute for a Fiduciary Standard.
And look, we look forward to having you back on the program again very soon, sir.
Knut A. Rostad, The Institute for the Fiduciary Standard