By January 1, 2015, there were 1,345 alternative mutual funds promising hedge fundstyle diversification in a daily-liquid wrapper.“ Guess how many of those alternative funds still exist?” asked Ptak in a new analysis.“ Three hundred and forty-one. The other 1,000 or so have been liquidated or merged away, a 75 % mortality rate.”

Not surprisingly, the death rate for alts funds is higher the further back you look. But whether the fund was launched around the time of the global financial meltdown or in the years that followed, analysts have seen a lot of them go extinct.

Now,“ as fund companies race to bring fee-rich private equity and debt strategies to the masses, the binge-purge pattern we’ ve seen with liquid alternative funds holds three key lessons for investors,” argues Ptak, who is the managing director for Morningstar Research Services.

The lessons for advisors considering adding alts to client 401( k) s are these:

• They should beware the overhyped sales pitch. A decade ago, fund companies promised that liquid alts would be the“ shock absorbers” portfolios lacked. The reality was far less impressive, and performance often lagged in rising markets.

• The hotter the trend, the greater the caution. Heavy product launches often signal a supply-driven wave that precedes disappointment.

• Advisors should dig deeper into the payoff story. Private investments can smooth returns partly because of their infrequent valuations— but that comes at the cost of locking up capital.

Liquid alts, however, at least allowed dissatisfied investors to sell. In private funds, that escape hatch rarely exists, Ptak notes.

Since 2017, new liquid alternatives have emerged for risk-averse investors. Buffered or defined-outcome ETFs with much lower expense ratios are now an option for advisors and investors seeking limited upside gains in return for downside protection.

These vehicles have reportedly raised more than $ 30 billion. Significantly, some pension funds and endowments have dumped high-cost hedge funds in favor of these ETFs with real-time liquidity.

For fiduciaries, the idea of private market investments being pushed inside 401( k) plans isn’ t just an investment question— it could also likely raise worries about how they

For fiduciaries, the idea of private market investments being pushed inside 401( k) plans isn’ t just an investment question— it could also likely raise worries about how they fulfill their fiduciary duties. fulfill their fiduciary duties and minimize their liabilities.

“ This will absolutely increase fiduciary exposure and E & O insurance premiums,” warns Kevin Thompson, president of 9I Capital Group.“ If they underperform and overcharge, plans will be vulnerable to class actions.”

Knut Rostad, president of the Institute for the Fiduciary Standard, calls the president’ s executive order“ a full-frontal assault on the heart of fiduciary” standards. He questions whether participants will even be able to opt out if alternatives are embedded in target-date or managed funds.

Phyllis Borzi, a former Department of Labor official and fiduciary expert, was blunt about the risks during the institute’ s recent webcast on Trump’ s executive order:“ If you can’ t see it, can’ t value it, and can’ t explain it, you shouldn’ t put it in your plan.” She points to the lack of transparency in fund-of-funds structures, where plan sponsors may not know what underlying assets are held or how they’ re valued.

Cost is another sticking point. Target-date funds built on flagship index strategies can have fees under 0.10 %. A 20 % allocation to private equity could quadruple those costs.

“ Plan sponsors [ that ] long focused on low-cost menus must now contend with complex, high-fee private market structures,” said Morningstar’ s Hal Ratner.“ While current demand is limited, the push is primarily supply-driven by asset managers eyeing the $ 12.5 trillion DC market.”

Tim McGlinn of The Alt View notes it’ s a lucrative proposition for fund companies: a BlackRock target-date fund adding 20 % in alternatives will see its expense ratio jump from nine basis points to 38— more than quadrupling revenue for the provider.“ A reasonable fiduciary has to ask: How is this affecting what they’ re selling?”

Thompson is even more direct:“ Private equity needs new capital. The individual highnet-worth market is drying up. So now they’ re coming after the defined-contribution market. It’ s a liquidity play.”

Continued on page 11

WWW. FA-MAG. COM