Alternative Investments in Employee Benefit Plans
The first post of a 2-part series.
Many plan sponsors are revisiting investment strategies historically employed when making investment decisions. As a result, employee benefit plans are holding more alternative investments, or investments without a readily determinable fair market value such as common collective trusts (“CCT”), pooled separate accounts (“PSA”), hedge funds and limited partnerships. As long as the plan document allows for such investments, decisions to revise a plan’s investment policy to add alternative investments are appropriate. However, plan sponsors will benefit from considering the following in addition to considering the investment risk related to alternative investments:
Investment selection and ongoing due diligence – The criteria for evaluating alternative investments requires expertise that may be historically unavailable to plan sponsors, therefore additional investment advisors may be necessary. Once an investment is made, ongoing due diligence serves to assure the investment continues to meet the plan’s needs, and this ongoing task varies by investment type.
Supporting documentation – Such investments typically have specific underlying contracts that require signature by plan management. When signing such contracts we recommend great prudence, including careful review of contract terms affecting the plan as well as the plan sponsor company and implementing a policy to maintain signed copies. Terms may also include commitments to invest additional amounts in the future.
Liquidity of the investment – Many such investments impose restrictions on the frequency of liquidations, as well as restrictions prohibiting liquidation of the investment for a certain period of time after the initial investment is made. Both of these restrictions can be very challenging, especially in the employee benefit plan area where the priority is to pay benefits when due.
Determination of fair value – Determining the fair value of certain alternative investments, including CCTs, PSAs and hedge funds, is less cumbersome than others as such investments report a net asset value that can be used as a practical expedient to determine the fair value. The ability to obtain and transact at the net asset value is especially important for plan’s requiring an annual financial statement audit. Certain investments operate on a reporting delay whereby the alternative investment is unable to provide year end values in a timely fashion and thus plan custodians reporting data on the alternative investment may have values of one to three months prior to the plan’s year-end. This timing can be challenging as plan reporting on form 5500 is as of the plan year-end.