Brokerage used to whet broader appetites for DC investments

As employees look for ESG, cryptocurrency and other niche investments in their workplace retirement plans, employers increasingly are turning to self-directed brokerage accounts to accommodate their requests.

One defined contribution plan sponsor, energy services and delivery company AVANGRID Inc., in August, for example, added a brokerage window to its $2.4 billion 401(k) plan to give its more than 7,000 participants access to ESG and other funds not available in the plan's investment menu.

"ESG is something that's been heating up a little bit and we're not comfortable adding stand-alone ESG funds in the core lineup," said Paul Visconti, AVANGRID's Orange, Conn.-based director of retirement programs and investments.

With the new brokerage window, participants can now "dabble" in ESG and "go out on their own to the thousands of mutual funds" available in the marketplace, an option that widens their investment choices beyond the plan's vetted, low-cost lineup, he said.

AVANGRID's brokerage account is limited to mutual funds and exchange-traded funds, restricting participants from buying individual stocks as well as any investments already in the core lineup because participants already have access to those investments "at a cheaper price through the plan's lineup," Mr. Visconti said.

Participants can invest up to 95% of their retirement balance in the brokerage window. "You have to leave 5% in the core lineup," Mr. Visconti said.

Like many plan sponsors, AVANGRID wants to satisfy workers who want to invest in funds outside its core investment menu without assuming fiduciary responsibility for the outside investments they choose. Brokerage windows are not subject to the fiduciary protections of other in-plan investment options, and participants are responsible for determining whether the investments available through the windows are appropriate for them.

"It's a great opportunity for individuals who are passionate about investing to invest in funds that they want to see in the plan," said Rob Austin, vice president and head of research at consulting firm Alight Solutions in Cornelius, N.C. "It also absolves the plan sponsor of having to make fiduciary decisions about funds that they maybe don't feel super comfortable about."

Brokerage windows can also help plan sponsors fend off lawsuits over lack of sufficient investment choices, industry experts said.

T. Rowe Price Group Inc., for example, recently agreed to add a self-directed brokerage account to its $3.9 billion 401(k) plan as part of a $7 million agreement to settle allegations that the company offered only proprietary investments to the exclusion of less-expensive investments offered by other asset managers.

While AVANGRID added the brokerage window to allow participants to "play on their own" with ESG and other investments, it also factored litigation risks into its decision. "There are plan sponsors facing litigation over lack of plan options," Mr. Visconti said. "By providing the option to invest in thousands of other funds, we feel that risk is greatly mitigated."

To be sure, plan sponsor adoption of brokerage windows has been ticking up. Today, about half of all plan sponsors offer a brokerage account, up from about 1 in 8 that did so at "the dawn of this millennium," Alight's Mr. Austin said.

"We've seen steady but modest annual growth in the percentage of plan sponsors who have self-directed brokerage accounts," he said.

Mr. Austin reports that there's been "chatter" among plan sponsors considering brokerage windows, conversations fueled largely these days by interest in ESG. When certain funds become popular, he said, "there tends to be more of a spike among plan sponsors hearing from employees about putting those in the plan."

In the past, interest in everything from gold to real estate helped drive plan sponsor adoption of brokerage windows. "Last year, when cryptocurrency was doing well, we tended to see some plan sponsors get questions from participants about adding that to the plan," he said.

At Sony Corp. of America, participants using the brokerage account available through the company's $4 billion 401(k) plan are "experienced investors who want access to more sophisticated asset classes," while others are "socially conscious investors who want to save for their retirement as well as feel good about investing in socially responsible investment funds," said Jordan Backman, vice president and senior counsel of benefits and compensation at Sony in New York, in written testimony before the ERISA Advisory Council at a meeting of industry stakeholders in August.

"Providing them with access to the brokerage window encourages greater participation in the plan," he said during the meeting held to discuss the use of brokerage accounts in workplace retirement plans. Mr. Backman declined to comment on the brokerage account beyond what was in his testimony.

Along with ESG and cryptocurrency, Shariah-compliant investments are also being accessed through brokerage windows. "We certainly have been receiving additional questions around whether a brokerage offering would be something that plans might want to consider offering for Shariah compliance," said Angela Capek, record-keeping and operations platforms product area leader at Fidelity Investments in Raleigh, N.C.

Ms. Capek said that brokerage windows are becoming especially popular among millennials, who account for 48% of new account openings with Fidelity's self-directed brokerage offering, Fidelity BrokerageLink. In 2015, they accounted for 18%.

"Trending indicates millennials will surpass all other generations in new account openings very quickly," she said, adding that many millennials are also seeking to be more socially responsible with their investment choices.

Ms. Capek attributes the increased interest among millennials to social media forums and trading platforms, such as Robinhood Markets Inc., that have increased awareness of investing. "Market volatility around meme stocks in early 2021 awakened many young Americans to the possibility of investing and helped motivate them to start educating themselves," she said.

Some plan sponsors hesitate to offer brokerage windows because they fear participants might make unwise or overly risky investment choices, concerns that sponsors typically mitigate by limiting the investments available through the brokerage accounts they offer.

Sony, for example, includes only mutual funds and certificate of deposit options. "We purposely excluded any investment other than mutual funds or CDs to promote diversification and reduce potential exposure to significant losses from individual securities or non-traditional investments," Sony's Mr. Backman said in his testimony. The company also limits participant investment in the brokerage window to no more than 50% of a participant's plan account balance.

Plan sponsor concerns about brokerage windows are also mitigated by the fact that a small percentage of participants use the windows and those that do tend to be highly compensated with higher-than-average account balances, according to research by Alight, Fidelity and other industry experts.

Alight's Mr. Austin found that about 2.5% of participants use a brokerage account, a percentage that "never has budged all that much," he said. In keeping with the research, participant use of the brokerage accounts offered through AVANGRID's and Sony's 401(k) plans has been modest. Roughly 2.4% of AVANGRID's 401(k) participants use the brokerage window, which holds 2.1% of total retirement plan assets, Mr. Visconti said. Meanwhile, at Sony, 1.3% of participants use the window, which represents 0.9% of all plan assets, according to Mr. Backman's testimony.

Mr. Austin encourages plan sponsors to use brokerage accounts if "they feel like they have people in their organization who want to invest differently," adding that sponsors shouldn't "worry too much about abuse in the self-directed brokerage accounts by individuals."

People aren't "going to take all of their retirement savings and put it all into bitcoin," he said. "We don't see individuals operate in that manner."