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Can Open Multiple-Employer Plans serve as the catalyst to wider adoption of illiquid alternative asset classes in 401(k) plans?
While the connection may not be obvious on its face, Joshua Lichtenstein, an ERISA attorney and partner at Ropes & Gray, says the benefits that alternatives have served in defined benefit portfolios is compelling reason to expand the range of investment vehicles in 401(k) plans.
The fiduciary structure of MEPs could facilitate wider access to alternatives, thinks Lichtenstein.
"Defined benefit returns are higher and difference seems to be the use of alternatives," he said.
Illiquid alternatives like private equity, hedge funds, and real estate are staples in pension management. Some alternatives are available to investors in 401(k) plans. Data from the Plan Sponsor Council of America shows that about 11 percent of DC plans include some form of alternative asset class, typically through mutual fund TDFs.
Registered funds are limited to the amount of underlying unregistered investments they can include before tripping the Securities and Exchange Commission's definition of accredited investor.
That limitation, and a decade of fee-based lawsuits against sponsors of defined contribution plans, has left most employers leery of offering illiquid, opaque, and often expensive asset classes, even if those assets could enhance returns and retirement outcomes.
"It's impossible to talk about the DC landscape without talking about litigation risk," said Lichtenstein. "In my view, that has influenced the makeup of investment menus. The big movement has been to identify the lowest cost investment options to reduce litigation risk."
That could change with MEPs. Under the Setting Every Community Up for Retirement, or SECURE Act, which was attached to the funding package President Trump signed into law last week, large money managers can be the fiduciary sponsors of Open MEPs.
"Part of the challenge individual sponsors face when designing a menu with alternatives is they always don't have the infrastructure. It's more difficult to benchmark and compare private funds compared to public funds. But providers of Open MEPs will be sophisticated financial institutions. They understand how private funds work, the questions that need to be asked of fund managers, and how to evaluate their claims. And they have a broad view of what's available in the market."
SECURE allows recordkeepers, asset managers and insurance companies to sponsor Open MEPs. Still, industry will enter 2020 waiting for the Labor Department to issue clarifying regulations on MEP sponsorship.
While SECURE is positioned toward small and midsized employers that don't offer retirement plans, nothing in it limits the size of employers that can join an Open MEP, which allows unaffiliated employers to pool workers under one centralized MEP that is run by a fiduciary.
"There is no restriction in the Act as to the size of employer that can joint a MEP," said Lichtenstein. "We think the conversations on alternatives in DC plans that have been ongoing could become more real. Financial Institutions will want to do this because it could provide a competitive advantage, and that could open larger scale plan design to a broader range of employers. Not just for big plans, but small plans as well."
If Open MEPs prove to be a catalyst to wider use of alternative investments in 401(k)s, two things will have to happen, says Lichtenstein.
A lawsuit against Intel Corp. in the Ninth Circuit over its use of alternative assets in its 401(k) will have to have a favorable result for the company. The case was recently argued before the Supreme Court on a statute of limitations question.
If the case is remanded back to the district court, tried, and ruled on in favor of Intel, the role of alternatives in 401(k)s will be encouraged, to a degree. If the lower court finds Intel's fiduciaries mismanaged the plan by including alternatives, the opposite would be the case.
The other factor will be the type of regulations Labor produces.
"A lot will depend on what Labor puts out and when. If they put out early guidance that provides enough for industry to move on, things will happen more quickly. If the guidance is too vague, it will take a longer time," said Lichtenstein.
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Nick Thornton
Nick Thornton is a financial writer covering retirement and health care issues for BenefitsPRO and ALM Media. He greatly enjoys learning from the vast minds in the legal, academic, advisory and money management communities when covering the retirement space. He's also written on international marketing trends, financial institution risk management, defense and energy issues, the restaurant industry in New York City, surfing, cigars, rum, travel, and fishing. When not writing, he's pushing into some land or water.
