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The battle of words between the alternative investments industry and all others about whether alts belong in 401(k)s is far too familiar today. The two sides speak different languages. They don’t engage each other.
The industry speaks of “better returns,” “choice,” and “diversification.” The recently signed “Democratizing Access to Alternative Assets for 401(k) Investors executive order urges alts with the rationale, “democratizing access.” Meanwhile, just about everyone else speaks of why alts should be avoided: high costs, illiquidity, opaqueness, complexities, and risks. No wonder fiduciary advisors generally steer clear of them.
There is no public discussion between Wall Street’s alts industry and advocates for retirement savers; that is, no discussion where each side can challenge the other on specific points. There is no attempt by the Wall Street alts industry to explain the negatives of alts — especially the challenge of selling illiquid holdings that are valued by the manager rather than the market.
This silence is deafening. What we hear instead are terms like “choice” or “new opportunity” or “democratization” without explanation or context. These mere utterances are designed to sell — not to inform or enlighten.
This silence underscores the weakness of the case for alts in 401(k)s. It underscores implicitly that alts are essentially antithetical to fiduciary advice. That is advice that conforms with the well-established fiduciary principles that are set out by the Investor Advisers Act of 1940 and the Department of Labor’s ERISA — advice that adheres to the duties of loyalty and care.
The weakness of the case for alts is evident in its opponents’ arguments. The WSJ’s Jason Zweig lambasted alts in “Wall Street’s Big, Bad Idea for Your 401(k)” Zweig’s first sentence, “Wall Street is promoting a colossal lie.” Zweig is in good company.
David Swensen was Yale University’s endowment chief from 1985 until his death in 2021. He used alts extensively and successfully. For many professional investors, Swensen was the world’s greatest authority on alts. He always recommended that individual investors not use alts, because he knew how difficult it was for professional investors to succeed with such investments. Swensen always advised individual investors to stick to index funds.
There are a few advisors in favor of alts who try to engage in a discussion, such as Chuck Failla, CEO and founder of Sovereign Financial Group. , He raises a few points that deserve comment.
First, “I believe Alts should only be available to individuals who understand them and can properly plan for the lowered liquidity generally found in Alts.” I agree with Failla and estimate that only 0.01% of individual investors understand alts; that is, 0.01% can cogently describe their positive and negative features and make a reasonable judgment.
Second, he makes the fair point that an investment vehicle cannot be judged separately from a specific recommendation to a specific client. However, there is precedent, of course, for exceptions to this rule: The SEC denies or limits certain investments to investors who are not “accredited.”
There is a third point that Failla and others allude to: what a plan participant faces sorting through investment options, on their own, when alts are often tucked away (hidden) in target date funds — they are either difficult or impossible to recognize.
Alts are not “required,” and there is no compelling reason to add them to a 401(k) plan — the single account that most retirement savers rely on to fund their retirement. This is the account that should be exposed to the least amount of risk.
A major push by the alts industry after the 2024 election is no surprise. The financial industry has battled to diminish or decapitate fiduciary duties in Washington for 17 years. What is noteworthy is that this White House-directed change seeks to set back federal securities regulation some 85 years — in the name of “democratization” absent any public discussion.
Knut Rostad is co-founder and president of the Institute for the Fiduciary Standard, a not-for-profit dedicated to furthering fiduciary principles in investment advice through education and advocacy.
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Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
