Strategic Risk Mitigation for Alternative Investments in DC Plans

Integrating alternative investments such as private equity, real estate, and infrastructure into professionally managed multi-asset products like target-date funds (TDFs) can offer significant diversification and return potential. However, these assets also introduce unique risks and operational complexities. To ensure prudent management and regulatory compliance, organizations must adopt a comprehensive set of risk mitigation strategies that address allocation, documentation, due diligence, ongoing monitoring, diversification, liquidity, fee benchmarking, operational readiness, and regulatory standards.

Start with modest allocations. Limit exposure to alternative assets, especially within professionally managed products like TDFs, to reduce risk. For example, organizations may cap private market investments at a small percentage, such as up to 15%. This approach helps prevent over-concentration and allows investment teams to gain experience with alternatives in a controlled manner.

Thorough documentation is essential. Carefully record all decisions, risk assessments, and ongoing monitoring activities to demonstrate prudence and compliance. Using standardized templates to document the rationale, risk assessment, and monitoring procedures for each alternative investment decision ensures consistency and transparency.

Robust due diligence should be conducted when selecting managers and asset classes. Evaluate managers by reviewing their historical performance, operational capabilities, and alignment with plan objectives. Only managers with proven expertise in private markets should be considered for inclusion in the portfolio.

Ongoing monitoring is crucial. Set up quarterly reviews of manager performance and fund operations to identify underperforming managers or operational issues early. Replace managers who do not meet expectations promptly, even if redemption constraints require advance notice.

Diversification is a key risk management tool. Include alternatives as part of a diversified portfolio, combining private equity, real estate, and infrastructure with traditional public market assets. This reduces the impact of poor performance in any single asset class and helps achieve more stable returns.

Liquidity management must be prioritized. Structure investments so that the majority of assets remain in liquid public markets, ensuring sufficient liquidity for participant-level trading and plan-level redemptions. Evergreen private-market funds, which offer periodic liquidity and continuous deployment, can help balance alternative exposure with liquidity needs.

Fee benchmarking is important for fiduciary responsibility. Compare fees for alternative investments against similar private market funds, not just public market benchmarks, to ensure reasonableness and protect participants from excessive costs.

Operational readiness should be confirmed before implementation. Work with recordkeepers and platforms to ensure they can manage non-daily-valued assets and address any platform or cost challenges. This preparation helps avoid operational disruptions and ensures smooth integration of alternatives.

Regulatory compliance is essential. Monitor regulatory updates and wait for clear guidance before adding alternatives. Reference ERISA and Department of Labor standards in all documentation and decision-making to ensure compliance and protect both the organization and plan participants.

Embed alternatives in managed solutions. Offer alternatives within TDFs or managed solutions to avoid individual investor hurdles and operational concerns, rather than as stand-alone private funds. This approach streamlines operations and enhances participant protection.

Conclusion

By implementing these risk mitigation strategies, organizations can prudently incorporate alternative investments into their portfolios while maintaining compliance, operational efficiency, and participant protection. Starting with modest allocations, documenting decisions, conducting thorough due diligence, monitoring performance, diversifying assets, managing liquidity, benchmarking fees, ensuring operational readiness, and adhering to regulatory standards all contribute to effective risk management. Embedding alternatives within managed solutions further streamlines operations and safeguards participants, enabling organizations to achieve their long-term investment objectives.

Bridgebay Financial, Inc. provides comprehensive due diligence to protect plan fiduciaries, enhance transparency, and improve participant communication. The firm leverages technology to offer cost-effective investment solutions and adheres to the highest professional standards set by the CFA Institute and IMCA.

Bridgebay’s advisory services focus on:

• Retirement Plan Services

• Institutional Investment Consulting

• Treasury Management Consulting

Specialty services include RFP search and evaluations for pension consultants, OCIOs, multi-asset class managers, co-fiduciary managers, investment managers, diversity-owned managers, ESG managers, custodians, and recordkeepers.

Bridgebay does not manage or custody client assets, nor participate in wrap-fee programs. Clients include corporations, defined contribution plans, foundations, and not-for-profit organizations.