Lessons from Alternative Mutual Funds for 401(k) Advisors
A Morningstar report takes a look at how mutual funds have fared in the private market and analyzes how their course signals potential implications for 401(k) investors.
The report, authored by managing director of Morningstar Research Services Jeffrey Ptak, notes that the number of alternative mutual funds has severely declined since 2015. Only 341 of the 1,345 funds exist today, with the other 1,000 having been liquidated or merged into other investments. In the past decade alone, these funds have experienced a 75% mortality rate, Ptak reports.
As alternative asset managers celebrate the push to private market investing in retirement plans, Ptak warns of the consequences that could arise in offering the funds to 401(k) investors and provides recommendations for retirement plan advisors.
He observes that while companies have touted alternatives as a way to further diversify investments, the funds’ high fees, complex nature, and illiquidity could be enough to turn investors and advisors away from utilization.
“They’re salivating at the opportunity to tap in the trillions that are invested in the retirement system,” he said to 401(k) Specialist. “This is common, and so as representatives, be familiar with what’s coming your way.”
Further, in his findings, Ptak comments that while investors were able to pull mutual funds from holdings if they were unhappy, investors in private funds cannot.
He looks at the history behind alternative mutual fund investing: From Jan. 1, 2009, to Dec. 31, 2014, investors spent $117 billion of assets in these investments. They would ultimately pull their investments due to fears of an overall dismal performance, Morningstar found.
If 401(k) investors wanted to cash out, they would be unlikely to move their money as private market investors generally lock portions of wealth in investments for years without much ease for movement, Ptak states.
Further, retirement plan savers would be unable to move their savings out without being subject to the 10% withdrawal penalty.
If advisors are still considering offering alternatives, Ptak urges they understand the underlying investment processes that could generate high returns, and the lows that come with it.
They should also know the questions to ask fund managers, like what a sleeve in a qualified default investment alternative (QDIA) is comprised of, how much of it is comprised in private assets, how tradable is the fund, is it liquid or illiquid, how managers adapt to potential illiquidity in the case that participants want to move out, and how good of a deal could participants be getting.
The other item to understand is the quality of assets that a plan has access to, Ptak states. “With public markets, we’re all fishing from the same pond, but that can be different when it comes to alternative investments and private equity and private credit. It’s not always that leveled playing field, and there can be a difference in the quality of assets that you’re getting,” he explains.
Ultimately, Ptak says he’s concerned that defaulting participants into a strategy with private market investments could end up hurting their savings and breaking their trust in the retirement plan system. As workplace plans increasingly adopt automatic features, defaulting participants into a QDIA with private market investments could curtail that confidence, he adds.
“If you’re not careful, you can begin to fritter away all of the trust and confidence that you have engendered in getting people to agree about auto-enroll and dump their money into TDFs in the first place,” he said. “The industry needs to be very deliberate and thoughtful to prevent a scenario from happening where investors come to lose confidence in a system that they’ve shown increasing signs of confidence in over the past few decades.”
Amanda Umpierrez is the Managing Editor of 401(k) Specialist magazine. She is a financial services reporter with nearly a decade of experience and a passion for telling stories and reporting news. She is originally from Queens, New York, but now resides in Denver, Colorado.
