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Ropes & Gray attorneys provide timely analysis on legal developments, court decisions and changes in legislation and regulations.
David Kirchner: Hello and thank you for joining us today. I’m David Kirchner, a principal in the benefits consulting group in both Boston and San Francisco, and I am here with my colleagues, Sharon Remmer, an ERISA and benefits partner in our New York office, and Elliot Saavedra, a senior benefits consultant who is based in Boston as well. In today’s episode, we will be discussing the opportunities and practical considerations arising from President Trump’s recent Executive Order that encourages expanded access to alternative assets, such as private equity, private credit, real estate and other nontraditional strategies, in defined contribution, or DC plans.
The Executive Order has generated significant attention from asset managers who see the DC plan market as a strategic entry point for the next phase of alternative investment growth. Already, there has been a lot of activity among asset managers and target date fund providers in terms of developing product offerings for DC plans, and we haven’t even gotten further guidance or a possible safe harbor from the DOL, as called for in the Executive Order. Once the DOL acts in the coming months, we anticipate that asset managers across the board will be highly focused on DC plan options with alt access.
But taking a step back, for our plan sponsor clients this may seem like a big leap, particularly given the current retirement plan litigation landscape – much of which focuses directly on the investment options offered to plan participants. While a lot of the buzz around this topic seems focused on the expanded market and new opportunities for asset managers, we’d like to focus today on what plan fiduciaries and their advisors should be thinking about and what they should be doing to prepare for this shift in the marketplace. Are alts really the next big thing for DC plans? What should plan fiduciaries and their advisors be prepared for once these investment options become available? To help answer these gating questions, we thought it would be important to look at the Executive Order, and emerging developments in this space, from the plan fiduciary’s perspective. With that context, Sharon and Elliot, can you set the stage for our audience and explain what the Executive Order does and does not do?
Sharon Remmer: Sure, David, as we have been telling our clients, the Executive Order does not change ERISA’s substantive fiduciary standards. Instead, it directs the DOL to clarify the fiduciary framework for selecting investment options that might include alts, to consider appropriately calibrated safe harbors and to reduce litigation frictions that have historically discouraged plan fiduciaries from considering alternatives. The Order also directs the DOL to collaborate with the SEC to revise the “accredited investor” and “qualified purchaser” criteria currently in place for alternatives in order to promote increased access. In short, the Executive Order stands for the proposition that DC plan participants should have access to a diverse range of investments, whether it is private equity or private credit, real estate, digital assets like cryptocurrency, commodities, etc., but only where appropriate and where any potential decision to provide access is the result of a careful and thorough prudent review of a plan’s investment menu and a well-documented process by plan fiduciaries. This is no different than what plan sponsors should be doing today.
Elliot Saavedra: I completely agree with Sharon. The key message for plan fiduciaries from the Executive Order is that it is a policy nudge, not a mandate. Access to alts may be expanded prudently where the fiduciary process is thorough and robust. And, as you noted in the beginning, David, the market is already responding with designs that aim to balance diversification and long-term return potential that these asset classes can provide, while addressing retirement plans’ demands for daily valuation and liquidity.
David Kirchner: Why do you both think there was a perceived need for this policy nudge? In other words, why have fiduciaries historically avoided alternative investments in DC plans? Are there certain core risk issues they should understand?
Sharon Remmer: Picking up with what Elliot noted, let’s start with liquidity and valuation. Most alternatives don’t trade daily like typical mutual funds or CITs available to DC plans, yet DC plans need daily pricing in order to provide routine liquidity for contributions, exchanges and withdrawals. Now, the solutions that have been developed in recent years generally rely on an “alternatives sleeve” within an asset allocation fund like a target date suite. The fund as a whole can strike a daily NAV using established valuation policies, while managing cash flows with a substantial liquid investment core. So that’s the first piece of the puzzle. It’s worth noting that the Executive Order mainly speaks to access to asset allocation funds containing alt investments, rather than direct alt investments.
Next, there is the issue of the investment fees generally paid by plan participants from their account balance. Alternative strategies usually carry higher costs and different fee structures than the mutual funds that have historically populated DC plan menus, so fiduciaries must evaluate the all-in net value and whether the cash liquidity issues balance favorably with the potential added returns, not just price tags. For experienced fiduciaries, this may feel similar to balancing the pros and cons of active vs. passive management in different asset classes.
Finally, how are plan fiduciaries and their investment advisors supposed to perform their benchmarking when, at least at the current time, there are few, if any real historical apples-to-apples benchmark comparators for these types of investments? In prior Ropes & Gray podcasts and client alerts, we have discussed the recent case Anderson v. Intel Corp. Investment Policy Committee, which involved a defined contribution plan that invested in private equity and other alternatives. Plaintiffs claimed that the committee breached its fiduciary duties by including these alternatives on the investment menu, but the court rejected these assertions. While the decision to grant Intel’s motion to dismiss was mainly based on the plaintiffs’ failure to identify “meaningful benchmarks” against which to compare the performance of the Intel funds, it is notable that the plan fiduciaries used customized benchmarks to evaluate the alternative investments, which gives credence to the idea that such an approach is consistent with a prudent process. So, while Intel’s win is instructive, it is not binding authority throughout the U.S. Still, it seems reasonable to anticipate that courts will look for “meaningful benchmarks” aligned with a fund’s aims and risk profile, and they will respect a tailored, well-documented benchmarking approach when off-the-shelf comparators don’t fit. The expectation would be that over time, apples-to-apples benchmarks will become more widely available, lessening the impact of this potential barrier. When the time comes to evaluate funds with alt components, the consensus is that fiduciaries will largely rely on their investment advisors, and guidance from the DOL, for suitable benchmarks. A good analogy for this might be when target date funds first hit the scene and there weren’t really any benchmarks – this issue was solved relatively quickly, and target dates became the QDIA of choice.
Elliot Saavedra: We could also add that operationally, plan fiduciaries will need to continue to be diligent when it comes to determining what type of funds to evaluate, whether it be a CIT or a mutual fund. Fiduciaries will need to ask a number of questions about these funds, including who selects underlying managers, how valuations are determined daily, and how the product maintains participant liquidity throughout the life of the investment. While I don’t think any of these hurdles are insurmountable, they will require discipline, a prudent process, and collaboration with experts.
David Kirchner: Those are all excellent points, Elliot and Sharon. Given the current ERISA litigation landscape, I don’t think we can ignore the potential retirement plan litigation risks that may be associated with these products. While DOL guidance may offer some relief through safe harbors or other regulatory actions designed to curb litigation, as we now know all too well, the plaintiffs’ firms target a plan sponsor’s process deficiencies. That’s why it is so critical that fiduciary committees have a clear, contemporaneous record of diligence, that their rationales for investment decisions are well-supported and that they are engaging in ongoing monitoring. Now, let’s shift gears and talk about how the investment advisors to the plans are reacting to the Executive Order. What have we heard from the investment advisor community on these recent developments?
Elliot Saavedra: David, I think many advisors are cautiously constructive. They generally see the potential for improved diversification and upside here that complements what plan menus already offer in terms of their public debt and equity offerings.
At the same time though, there is a sense among some advisors that it is best to wait until the DOL provides a safe harbor or additional framework for how plan fiduciaries can offer exposure to alts in a manner that would satisfy ERISA’s standards. Preliminarily, we are hearing that investment advisors are focused on ramping up their knowledge base and evaluating resources and tools to be able to quickly respond and hit the ground running when the DOL issues guidance. Now is the time for them to begin to educate plan fiduciaries about the basics of these funds that incorporate alternative investments, including their general characteristics and potential ability to enhance participant returns over the long term.
Sharon Remmer: When it comes to how advisors are evaluating these products, I think it really hinges on how the particular manager, its portfolio construction and implementation fit within a DC plan. Advisors may have some data available on manager-level track records, and many also have proprietary scoring frameworks for qualitative metric due diligence, which are as important as performance metrics for fiduciary comfort.
Additionally, advisors are looking at different allocations along a TDF glidepath and seeing how that could potentially impact expected returns over time, along with volatility and drawdown characteristics in a significant market decline causing a sell-off. Since liquidity is such an important consideration in this space, advisors will need to stress test their models to determine what happens under different liquidity scenarios --- particularly in the event of a mass drawdown.
Advisors are also considering how a significant increase in cash investment driven by retirement plan money entering private markets might force private market managers into less appealing investments – potentially eroding their historic success in achieving higher returns.
As we mentioned earlier, one of the current challenges in this space is the lack of robust third-party benchmarking. Like in Intel, advisors may have to build custom synthetic benchmarks that mirror the TDF sleeve’s target asset mix, investment horizon and risk. The availability of these benchmarks will be key in the plan fiduciary’s process for evaluating alt investments. All of this said, advisors are largely waiting for framework in the form of guidance from the DOL in order to help them advise plan fiduciaries appropriately.
David Kirchner: We have mentioned how there are some product offerings currently on the market that already provide access to alts. Can you provide our listeners with a bit more context as to what structures are most common, and how soon might fiduciaries see these options become more broadly available?
Sharon Remmer: As noted earlier, the Executive Order contemplates access primarily through asset allocation funds. In practice, that means target date fund CITs or mutual funds, or an actively managed account option embedding a relatively small sleeve of alternatives within a highly liquid core. Interval or tender-offer funds may also be utilized as well, provided daily NAV can be struck reliably and liquidity can cover the needs of DC plan participants. We expect meaningful availability to expand over the next 12–24 months as asset managers finalize designs and find partners (i.e., TDF providers) to bring these products to market.
Elliot Saavedra: We should also mention that there are specialized pooled employer plans (PEPs) that have started to offer some of these products through managed accounts, and the custom TDFs for the mega plans are probably the furthest along in terms of embracing alts (think plans like Intel’s). That all said, broad platform availability for mid-size plans is rapidly developing, and it is a good time for investment committees to begin education and market surveys now, even if adoption is a 2026–2027 consideration based on the anticipated timing of the DOL guidance.
David Kirchner: Given this expected time frame, what do you think fiduciaries who are interested in exploring these products should be doing in terms of immediate next steps?
Sharon Remmer: First, kick the tires on your fiduciary governance. Ensure that you have formed a fiduciary committee with sound and structured fiduciary process in place for selecting and monitoring plan investment options – including hiring an independent investment advisor. Next, learn the basics. Fiduciary committee members should understand how these funds work, what role they might play in a DC plan menu, and whether they would be appropriate for their plan participants. Plan fiduciaries should tap into the knowledge and skillsets of their investment advisor and legal counsel in this educational effort.
Moving beyond fiduciary education, committees can update or reaffirm the plan’s investment policy statement to address asset allocation vehicles with alternatives, including benchmarks, guardrails and monitoring.
At the end of the day, fiduciaries should remain patient and monitor for, and digest, DOL and SEC guidance as it becomes available. When the time comes, fiduciaries should be prepared with questions to ask their investment advisor – including questions mentioned in this podcast – if they are beginning to evaluate investments that include alts.
Elliot, do you want to walk through what this diligence effort might look like, and how committees may have to rely on their investment advisors in this regard?
Elliot Saavedra: Sure thing. As Sharon mentioned, reliance on the investment advisor will be critical in this arena, especially for committee members who are unfamiliar with these asset classes. Committees will want to engage with their investment advisor to survey the market and analyze whether these products are suitable for their plan participant demographics. Moreover, they can help develop the appropriate due diligence questions to ask managers and TDF providers and organize information in a comparative format. Examples of diligence questions might include:
How is this alternative investment structured?
Who is selecting the underlying private investment manager(s)?
What is in the track record of the private investment manager(s)?
What are the underlying investments (for example, private companies, private credit, specific industries)?
How are they evaluating and selecting the alt investments?
What processes do they have in place for compliance with ERISA and avoiding prohibited transactions?
How are the fees being calculated for the fund overall?
How will those fees be disclosed to participants who elect to participate in the fund?
If the asset allocation fund is a CIT, it will be deemed to hold plan assets. This means that the CIT manager will be an ERISA fiduciary, and additional diligence questions and evaluation will be appropriate in that situation.
For private market professionally managed account products, fiduciaries will want to confirm the independent firm that is responsible for developing the allocation models, how the alternatives exposure will differ from the core lineup, how the manager will provide personalized allocations based on age, savings rate, outside investments and account size, and the participant fees associated with using managed accounts.
Fiduciaries will also want to assess their operational readiness as a practical matter, which will encompass a whole host of issues like custodial and recordkeeping capabilities for daily NAV; valuation oversight; fee mapping and disclosures; and integration with your current offerings. Finally, fiduciaries will want to explore developing a participant communications framework for proper disclosure of the investment’s risk, return, and fees, while also considering the level of financial acumen of their participant base to help determine the level of detail needed to fully educate participants before they invest.
David Kirchner: Based on everything you both said, it seems like even if the decision of whether to adopt is not right around the corner, early groundwork will position your fiduciary committee to act prudently and in the best interest of plan participants when the DOL guidance becomes available.
Ultimately, in the absence of DOL guidance, it is difficult to predict what the appetite will be for these asset allocation products. In the current litigation landscape, as reenforced throughout this podcast, good fiduciary governance will be as important as ever. Access to these investments will be new – and while plan fiduciaries understandably want to ensure that their participants have access to a variety of options – it makes sense to proceed carefully and deliberately, and actively engage with your investment advisor to evaluate the marketplace.
That concludes our podcast on alternative investments in DC plans. Thank you so much for joining us today. Keep a lookout for any future DOL guidance and be sure to check back here for more information as this area evolves. You can also subscribe and listen to this series wherever you regularly listen to podcasts, including Apple and Spotify. Thanks again for listening and take care.