Many investment professionals recommend that their private wealth clients allocate a portion of their portfolio to alternative investments. These include real estate, private equity, cryptocurrency and commodities. The reason is that these investments move in the opposite direction to stocks and cushion volatility. In fact, a recent study indicates that including alternative investments in a portfolio can increase return by 5%.
Defined benefit plans already have allocations to alternative investments. Given recent volatility in both the stock and bond markets and the withdrawal of the Department of Labor’s warnings against investments in cryptocurrency, plan sponsors may be considering whether their 401(k) plan participants should also have the opportunity to benefit from alternative investments. They may also be hearing pitches from financial firms, which have been open about their interest in marketing private equity investments to 401(k) plans.
Why ERISA Plan Investments are Different. While there are sensible arguments from the investment side for considering whether to make investments that large investors can access available to 401(k) plan participants, adding alternative investments must be done in a way that fulfills ERISA fiduciary responsibilities and protects participants who may not understand how these complicated investments work from losses due to uninformed decisions. Wealthy investors and defined benefit plan sponsors may be able to absorb large losses, but 401(k) plan participants are undersaving for retirement as it is, and any losses would directly reduce their account balances.
Special ERISA Challenges. ERISA imposes several restrictions on fiduciaries looking to add alternative investments to their plans. First, they must satisfy the fiduciary duties of prudence, loyalty and diversification when selecting alternative investments, including making sure that the fees are reasonable in relation to the services provided. Fiduciaries must also avoid non-exempt prohibited transactions, consider plan liquidity requirements, and deal with hard-to-value assets and custody issues.
The Legal Framework. Although ERISA does not contain lists of permissible and prohibited investments, the Internal Revenue Code prohibits 401(k) plans from investing in collectibles such as art or oriental rugs. An exception to the prohibition permits investments in precious metals such as gold bullion. The Department of Labor issued Information Letter 06 03 2020 during the first Trump administration indicating that plans could invest in private equity as part of a diversified pool of investments, such as a professionally managed target date fund. The Biden administration tried to walk this back in supplemental cautionary guidance. However, Dan Aronowitz, the nominee set to assume leadership of EBSA, has publicly stated his intention to allow fiduciaries to make their own investment decisions, and nobody expects the Department of Labor to restrict private equity investments in the foreseeable future. Despite withdrawing earlier Department of Labor cautions against investing in cryptocurrency, the Trump Administration hasn’t issued any specific guidance on how to handle cryptocurrency investments.
Favorable Legislation Introduced. Sen. Tommy Tuberville and Representative Byron Donalds have reintroduced The Financial Freedom Act. This legislation would prevent the DOL from prohibiting plans from making or disfavoring any particular classes of investments. It would clarify the law, but its prospects for passage are unclear.
The Intel Decision. The Court of Appeals for the Ninth Circuit provided additional support for alternative investments on May 22 when it dismissed a lawsuit challenging Intel plan investment in private equity and hedge funds through proprietary funds. (Anderson v. Intel Inv. Policy Comm., No. 22-16268, 2025 BL 176095, 2025 Us App Lexis 12481.) The Court determined that plaintiffs had not supported their claims of violations of the responsibilities of prudence and loyalty.
Plaintiffs had claimed that these investments “departed from the prevailing standards of professional asset managers” and tried to compare returns to an equity-heavy benchmark. In fact, by moving in the opposite direction to traditional investments, the Court found that these alternative investments had different goals than equity funds. The investments had served their intended purpose of cushioning volatility despite underperforming in a bull market. The Court also held that it was not a violation of the duty of loyalty for the plans to invest in the same investments as Intel’s venture capital arm.
In short, there is support for including these investments in 401(k) plans, but the devil is in the details.
Ways to Fulfill ERISA Responsibilities.
The following steps will help to protect both fiduciaries and participants:
· Make investments through a fund that is an investment company under the ’40 Act or a fund that is not treated as holding plan assets, such as a venture capital or real estate operating company, to access professional management and avoid inadvertent prohibited transactions. Prohibited transactions can occur when funds treated as investing the assets of the investing plans enter into sales, exchanges or extensions of credit with sponsors or service providers to investing plans and there is no available exemption. It should be noted that there are now SEC-approved cryptocurrency funds that are exchange traded. These funds had not been approved when the DOL issued its warning about cryptocurrency investments.
· If alternative investments are offered as designated plan investment alternatives, limit the percentage of account assets that can be allocated to alternative investments and provide for periodic account re-balancing. For example, the provider ForUsAll limits cryptocurrency exposure to 5% of a participant’s account. Provide clear communications to participants that explain the risks in nontechnical language and make clear that they could lose their entire investment. Don’t assume that participants will read through fund prospectuses to learn about the risks.
· Investigate custody arrangements to make sure they are institutional grade and that assets are not held outside the U.S. Be aware of and comply with special custody requirements applicable to investment in precious metals.
· Consider indirect investments that allow investors to benefit from gains in the investment class or market without directly investing in alternative assets. There are cryptocurrency funds that track the value of cryptocurrencies but don’t actually buy and sell cryptocurrency. For example. Fidelity offers a Digital Assets Account as an option for plan sponsors to include in their plans. These assets can be invested in other investment funds, and are not individual investments of participant accounts. There are also funds that invest in companies in the crypto industry such as blockchain companies.
· Make sure that you will get the information required to report the investment on Form 5500 and show returns on participant disclosures. Will an independent party determine the fair market value of hard-to-value assets? Will the fund manager make a Form 5500 filing directly with the DOL as a direct filing entity (DFE)? Filing as a DFE will greatly reduce the plan’s 5500 filing obligations related to the investment.
· Consider making alternative investments available through self-directed brokerage accounts where participants take on more responsibility for their investment choices. Even there, percentage limitations on these investments are appropriate since self-directed brokerage accounts are not limited to sophisticated investors.
Mitigating Litigation Risk. It is important to consult with experts in light of the heightened risk of litigation fiduciaries of plans investing in nontraditional investments can be expected to face. ERISA’s requirements should be met with the assistance of financial professionals and ERISA counsel. In addition, since these investments can be hard to understand and evaluate, the offering of alternative investments though professionally managed funds such as target date funds can help to mitigate the litigation risk. Although fiduciaries must make their own individual decisions about including alternative investments, they and their advisers can partner to determine that any designated investments are consistent with ERISA and that the decisions are carefully documented. Good written documentation creates a record of prudent decision-making that can be an effective defense if decisions are later challenged.