By William J. Kelly, CAIA, Founder & Managing Member, Educational Alpha LLC
The Executive Order (“EO”) has been issued, and we need to move on from the “why?” or “why not?” There is nothing more to add to what has already been said, and it is interesting to note that the vast majority of these opinions seem to reside in the far left or right tails of the debate. Most outcomes in business and life are within that one standard deviation of the mean, and it is there where we should come together, seeking and proposing the most sensible solution for the investor as we move on to the very important “how?”
The lobbyists for the asset gatherers have won this first round, and good for them, as they certainly have earned their keep. The next best move for them is to take a bow and step aside for a bit as we contemplate what this might mean for the asset owner (the individual 401(k) participant) and, of course, their fiduciary. According to the ICI, there are about 70 million active defined contribution participants in more than 715,000 plans. Those assets alone total $9 trillion. If we throw in self-directed IRA rollover accounts, we cross over the $15 trillion threshold.
The moment we begin monetizing a conversion factor of assets in motion from public to private equity (“for every 1% shift in retail investments to alternatives, the asset managers gain $150B of new subscriptions!”), we have lost the narrative. The size and power of the collective pool is formidable, and it is there where we must unionize and weaponize the voice of the participants. It is now up to the U.S. Department of Labor “to foster, promote, and develop the welfare of the wage earners, job seekers, and retirees of the United States” and the SEC who are “dedicated public servants who care deeply about protecting the investing public and others who rely on our markets to secure their financial futures” to do their jobs as the lobbyists for these investors. It is their assets and their time.
As we think about an elegant and even simple solution, let us first size the people’s $15T relative to some of the most sophisticated asset owners in the world. This pool of defined contribution assets is 9X the size of the Norway Government Pension Fund, 14X the size of the Abu Dhabi Investment Authority, and 362X the size of Yale’s Endowment. What these institutions have that the individuals want (and need!) are convening power and voice. This should be the entry point for the SEC and DOL, and the construct might already be mostly in place.
These august “welfare protectors” and “dedicated public servants” who have been charged with providing guidance should not simply default to the default option via (greater) alternative investment exposure in the Target Date Fund (“TDF”) structure. Ironically, this is where the managers and their aggressive lobbying agents are salivating, and this narrative is seemingly the pre-ordained conclusion.
Why would anyone suggest hitting the pause button on such an obvious solution? The answer can be found in a simple follow-up, and mostly rhetorical, question. How much would the sophisticated institutional investor allocate to these TDFs if they were made available to them at any fee structure? Of course, the answer is ZERO because a long-only portfolio manager is (hopefully!) adept at stock selection, but underwriting portfolio companies directly or via a general partner in the private capital space is a completely different skill set. Manager access, due diligence, and manger selection are everything. The skillful, long-only TDF portfolio manager who simply extends their mandate to the private markets is more likely than not to find themselves wallowing within the very wide chasm of performance dispersion.
Now for the solution. According to Plan Sponsor Council of America, almost 40% of DC plans already offer a self-directed brokerage account (SDBA) option to their plan participants. Perhaps noteworthy, too, is that the utilization rate for the SDBA vertical is negligible (see page 55 this Vanguard Viewpoints report), which indicates apathy and/or a lack of investor interest in trying to navigate the complexities of the underlying risks themselves. But… what if we took this same construct and institutionalized it while immunizing it from litigation risk, providing the individual with a solution that would make the late David Swensen salivate?
The SEC and DOL should create a world-class advisory committee of the best alternative investors. Their mandate would be to create a short-list (5-7 would be ideal) of competitively sourced superfund-like managers who would be the only ones to have access to this $15T pool. For the plan participant, this would effectively be another investment choice via a self-directed alternative risk premia account (“SDARPA”). If this is done right, this advisory committee could effectively create a Commonfund or TIFF-like structure that would manage and professionally protect the individual plan participants’ assets in a large, commingled fund with pari passau institutional access to the very best global managers under most favored nation fee schedules.
As an aside, the peoplesinvestmentfund.org domain name is available, and needless to say, the institutional lobbyist will hate this idea. If their bellicose refrain becomes “these investors need the liquidity only a TDF-type structure can provide,” such an observation is self-serving and disingenuous. We need to either do a much better job of explaining the power and purpose of long-termism (which we should do anyway) or simply remind the investor that there is no true liquidity when alpha is being sought via a highly illiquid investment choice.
For those DC plan participants who opt-in, it will be their choice, rather than having to passively accept alts exposure because it is now embedded in a (pedestrian) TDF. As an interesting side note, the oft-mentioned TDF solution is tantamount to an easy land-grab, as that same Vanguard report shows a big fat pitch of over 40% of the total plan assets already sitting there for the taking! For those who do make this SDARPA choice, there is no guarantee that they will have returns that are any better than the public markets, but at least they are standing at the starting line on equal footing with the most sophisticated investors in the world, and they have actively chosen to have this type of private markets risk exposure
And what if the usage rate for the SDARPA resembles the SDBA with very low single-digit exposure? It would seem to say that the investors have spoken. They either have no interest, or the industry simply has failed to present a compelling value proposition to those that own these assets and/or to those who advise them. This will create a healthy tension, which is what a fair capitalist system is all about, replete with an active choice that is in the hands of the consumer who owns these assets in the first place.
Seek education, diversity of both your portfolio and people, and know your risk tolerance. Investing is for the long term.
About the Contributor
William (Bill) J. Kelly, CAIA is the Founder and Managing Member of Educational Alpha, LLC where he writes, podcasts, and speaks on a variety of investment related topics, focused on investor education, transparency, and democratized access to differentiated risk premia. Previously he was CEO of CAIA Association since taking this leadership role in 2014 until his retirement in 2024. Prior to that, Bill was the CEO of Boston Partners, and CFO and COO of The Boston Company Asset Management, a predecessor institutional asset manager. In addition to his current role, Bill is also the Chairman and lead independent director for the Boston Partners Trust Company and serves as an independent director for the Artisan Partners Funds, where he is also Chair of Audit Committee and a designated Audit Committee Financial Expert. He is also currently an Advisory Board Member of the Certified Investment Fund Director Institute within the IOB (Dublin) which strives to bring the highest levels of professionalism and governance to independent fund directors around the world. Bill began his career as an accountant with PwC where he earned his CPA (inactive).
Learn more about CAIA Association and how to become part of a professional network that is shaping the future of investing, by visiting https://caia.org/