I don’t want to rehash all the reasons for my view that investors should avoid actively managed funds, expensive, complex investment products and “alternative investments” like hedge funds and private equity. If you find these investments suitable, you have every right to buy them.
Special issues with 401(k) plan participants
Employees with 401(k) plans, however, are in a different category. Their investment choices are typically constrained by the options offered in their plan. These funds are selected by the 401(k) plan sponsor, working with a broker or other advisor to the plan.
According to the U.S. Department of Labor, being a fiduciary means:
- Acting solely in the interest of plan participants and their beneficiaries and with the exclusive purpose of providing benefits to them;
- Carrying out their duties prudently;
- Following the plan documents (unless inconsistent with ERISA);
- Diversifying plan investments; and
- Paying only reasonable plan expenses.
In my opinion, populating the investment options of a 401(k) plan with expensive, actively managed funds, instead of low management fee index funds, passively managed funds or exchange-traded funds that have higher expected returns, violates the fiduciary duty of plan sponsors. So far, no court has adopted this view. I don’t know of any case where this proposition has even been asserted.
A proposed fix to a flawed system
Respected financial journalists, like John Wasik, apparently agree. In a recent column in Forbes he stated: “The process of improving returns is incredibly simple. If your employer was to get rid of all actively managed funds and replace them with passive index funds, you’d see immediate improvement.”
Compelling bad choices
A newly filed lawsuit against Intel Corp. makes these issues pale in comparison. The allegations in the complaint (which remain to be proven) question the inclusion of hedge funds and private equity as investments in Intel’s more than $14 billion defined contribution plans.
The lawsuit claims that, for an extended period of time ending this year, employees under age 50 were required to invest in a “Global Diversified” fund. In 2014, a significant portion of the assets of this fund (approximately 37 percent) were invested in hedge funds, private equity and commodities.
Intel’s savings plan included target date funds in which employees who failed to make a choice were automatically invested. These funds — unlike typical target date funds — also had significant exposure to alternative investments.
Data on alternative investments
It would seem to be difficult for a fiduciary to justify this conduct. The data on the dismal performance of hedge funds is readily available and well-known. Some of the largest pension funds in the world have looked at this data and dumped their hedge fund investments.
There are similar issues with private equity. As my colleague, Larry Swedroe, recently noted, private equity investments are illiquid, have high transaction costs and are difficult to value. Swedroe references studies finding that, when viewing risk-adjusted returns, private equity “didn’t deliver outperformance.”
The Intel lawsuit will slowly wend its way through the court system. It will be up to a federal judge to decide whether forcing (or encouraging) investors to make bad choices is consistent with the fiduciary obligation of a retirement plan’s sponsors.
What do you think?
This commentary originally appeared December 1 on HuffingtonPost.com
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