Just days after the Department of Labor (DOL) released a proposed rule that would allow the usage of private investments in 401(k) plans, some are questioning its overall impact to investors and savers.
Morningstar on April 1 published an article examining whether the investment options offer fee transparency to plan sponsors and participants. Under the proposed rule, when selecting investment alternatives, plan fiduciaries would need to objectively, thoroughly, and analytically consider, and make determinations on factors including performance, fees, liquidity, valuation, performance benchmarks, and complexity.
While Morningstar said it would ultimately analyze performance, liquidity, valuation, and complexity components, it argues that fee transparency is often the first component that plan sponsors look at when considering investments for the plan’s portfolio.
This is particularly true for collective investment trusts (CITs) in 401(k) plans, Morningstar stated. As CITs are regulated under the Employee Retirement Income Security Act of 1974 (ERISA) and the Department of Labor (DOL) rather than the Securities and Exchange Commission (SEC), the funds have different levels of reporting compared to other investment options.
“First, it is unclear whether CITs holding private market funds that charge incentive fees, such as carried interest, will be required to include those costs in the total net expense ratio shown to participants,” wrote Morningstar. “Second, mutual funds and exchange-traded funds must include the cost of leverage in their prospectus and annual report expense ratios, which can be a material expense for private credit, real estate, and infrastructure funds; there is no clarity yet on whether CITs will be held to the same standard. Third, it remains an open question how either of those costs will flow through as acquired fund fees.
“A welcome improvement to the final rule would be clearer guidance on how complex private market fee schedules should be disclosed to plan sponsors and participants,” the firm added.
Others have criticized the proposed rule for potentially exposing participants to private market assets, and especially to cryptocurrencies. Shortly following the release of the proposed rule, Senator Elizabeth Warren (D-MA) issued a statement condemning the rule for subjecting participants to the assets.
“As cracks emerge in the private credit market, private equity returns fall to 16-year lows, and crypto keeps tumbling, President Trump has decided now is the time to stick all of these risky assets into Americans’ 401(k)s,” said Warren in a statement. “Americans facing an uncertain future in Trump’s economy will now have more reasons to question the security of their retirement savings – all so that Trump’s Wall Street buddies have another pile of cash to play with. Anyone who cares about the financial security of working people should oppose this proposed rule.”
Charles Field, co-chair of Sanford Heisler Sharp McKnight’s Financial Mismanagement and ERISA Litigation practice group, voiced concerns over the fiduciary process when considering private market assets. While the DOL says it prioritizes the fiduciary process over investment products, Field is skeptical whether plan sponsors will lead with this same approach.
“Fiduciaries may abide by the small rules while violating the big ones,” he said. “Too often we see the fiduciary process is nothing more than fiduciaries checking the boxes, going through the motions, without doing any real investment analysis that maximizes monetary benefits for employees. Poorly performing and expensive investment options are kept inexplicably in plans much too long.”