Why Morningstar’s Christine Benz Isn’t a Fan of Alts in 401(k)s

Once a Boglehead, always a Boglehead.

Christine Benz, director of personal finance and retirement planning for Morningstar, is a proud member of the Boglehead movement, a popular investment philosophy based on the teachings of Vanguard founder John Bogle. Self-professed “Bogleheads” emphasize long-term wealth building through simple, low-cost and diversified index fund investing. The community focuses on minimizing fees, ignoring market noise and staying the course.

Benz’s enthusiastic participation in the Boglehead movement helps explain her reaction to the recent proposal by the Department of Labor to help “democratize” access to private assets like private equity, real estate and digital assets in 401(k) plans. That reaction was decidedly “meh,” especially factoring in the potential for higher fees after years of falling plan costs.

“401(k) plans have gotten meaningfully better over the past few decades as they’ve gravitated toward index funds, target date funds and smart defaults,” Benz said. “The new proposal doesn’t seem intended to build on those successes in any way.” 

Benz unpacked her reaction in a recent post on Morningstar’s website, where she points to four other pressing pain points that, in her view, should take precedence over the policy push for private assets in defined contribution plans. These include a lack of universal access to 401(k) plans, a serious difference in quality between large and small plans, challenges for job changers to remain on track, and a dearth of support for income planning. 

“It’s true that many workers are hurtling toward retirement with inadequate savings,” Benz said. “But this proposal seems more like a gift to what I call the ‘financial complexity complex’ than it is a boon to workers.”

That said, Benz believes the rulemaking’s asset-class-agnostic framework for more clearly defining prudence in the 401(k) plan investment selection process may prove helpful in stemming litigation filed against well-meaning plan sponsors under the Employee Retirement Income Security Act. Nonetheless, there’s a real risk that allowing 401(k) plans to add complicated, higher-cost investments to their menus is a step backward, and it detracts from what really matters. Benz sat down with Advisor Upside to chat about alternatives, the proposed 401(k) rule changes, and the current state of retirement income planning. 

AU: Were you surprised by the scope of the DOL’s proposal? A lot of people were expecting an alternatives-specific proposal, but what we got is a general framework for prudent investment selection writ large. Might that be a good thing for plan sponsors who are building investment menus?

CB: You are right that the proposal seems pretty uncontroversial on its face. We all want plan sponsors to be using prudence when assembling plan menus, and the specific criteria put forth all seem reasonable. 

But it seems pretty clear that the proposal, if enacted, would thrust the broad category of alternatives into the limelight as viable and readily defensible choices on 401(k) menus. It also seems unnecessary: Mutual funds already have the option to invest up to 15% of their portfolios in private securities and other asset types outside of their stated focus. Several Fidelity funds have taken advantage of this leeway to buy stakes in privates, for example. Additionally, many large plans already offer brokerage windows to allow participants to venture outside of the plan menu.

What kind of an initial reaction has your skeptical analysis of private assets in 401(k) plans generated among financial advisors serving retirement savers? 

Our individual investor/editorial team was quite unified. We all agreed that more choice is generally a positive, but also felt suspicious about industry’s influence in this context, and the timing. My former colleague John Rekenthaler asked: “What would Jack Bogle think?” “He’d hate it,” we replied in unison. We agreed Warren Buffett probably would too.

If asset managers were able to keep fees down, does the idea of getting private assets into target-date vehicles in itself raise any other issues for you? 

I wouldn’t rule out that a reliable player, like Vanguard, could successfully use privates in the target date context. But I would also approach backward-looking data on the performance of privates with a healthy dose of caution. The returns that you see bandied about for private equity often don’t include fees. 

More concerningly, one of the clearest relationships in investing is that returns correlate with risk. Reporting limitations impede our ability to get our arms around the risk that privates entail, but it seems certain that it relates to the return edge. 

All of the “pain points” you bring up are certainly valid and important to address. If you could waive a magic wand and see one of those issues corrected overnight, which would it be? Which is the most solvable, and which is the most difficult? 

I would endorse a two-part fix. First, raise the IRA contribution limits to match the higher 401(k) limits so people aren’t artificially constrained based on where they’re investing. Second, stand up a Thrift Savings Plan analog that would be accessible to anyone via automatic payroll deductions. Big employers could still field their own plans but this would help solve the accessibility and quality issues.