To understand the risk inherent in your 401(k) plan in a volatile financial market, you must understand the inter-relationship among various factors that make up the risk profile of your plan:

(1) the valuation method used for your plan assets,
(2) alternative assets held in your plan,
(3) market interest rates,
(4) investment duration, and
(5) leverage.

In volatile financial markets, these factors can act on one another–like falling dominoes–to create liquidity risk. Inadequate liquidity is nearly always the key to any market failure.

This article addresses all these topics, and more, to help you better understand and make sound choices for your 401(k) plan, as follows:

liquidity risk


Understanding how your plan’s assets are valued is the most important step in pension plan analysis. Plan advisors may present investment options as either “equities” or “fixed income.” But this distinction is too simplistic and ignores the characteristics and risks of assets that might be buried in each general category.

The key thing to look for is which assets are valued at level 1, and which assets are valued at Level 2 or Level 3, or are valued outside the fair value hierarchy.


Level 1 assets are highly liquid holdings, marked to market at least daily, on an active public trading market with ample trading depth, such as NYSE or NASDAQ. These are typically mutual funds and most ETFs.

You can readily identify the fair market value of your Level 1 assets on a daily basis; and can make informed re-balancing decisions that may be required, based on a clear understanding of the asset’s fair market value.

This is a principal goal of ERISA: that you are given sufficient information to understand the composition of your plan to make informed allocation decisions.

So, to the extent your pension plan holds Level 1 assets, you pretty much know where your plan stands, and what market risks you may expect. One caution, however, is duration risk and withdrawal limitations or penalties that can practically affect liquidity. And even though mutual funds and ETFs typically use “net asset value” (NAV) as a value reporting metric, the publicly-reported fair market value is almost always very close in value to the NAV.


On the opposite end of the valuation spectrum are assets traded over-the-counter (OTC) that are privately valued by the two trading partners outside the Fair Value Hierarchy, and reported at an arbitrary net asset value (NAV), such as asset cost or a nominal unit price of $1.00.  OTC NAV valuations say nothing about fair value of the asset. OTC asset trades are nearly always alternative assets held in a collective investment trust. These include holdings in hedge funds, private equity funds, real estate, asset backed securities, structured notes and other complex products. OTC-traded assets are not regularly marked to market, are typically valued at an arbitrary value, and therefore lack a clearly defined fair market value


Nowadays, many 401k plan options are distributed about  half-and-half: with about half of a plan’s offered investment options built around liquid, valued at Level 1; and the remaining half of a plan’s offered investment options built around assets held only at an arbitrary NAV, without reference to fair value, in a collective investment trust.

A plan option that includes alternative investments in a collective trust may be nominally described as “fixed income”–but if the assets in this option are not marked to market daily, they are high risk assets susceptible to evaporating liquidity in a down or volatile market.

Again, these include holdings in hedge funds, private equity funds, real estate, asset backed securities, structured notes and other complex products. Compare, for example, standard bonds, with a fixed duration and coupon, that are traded on a public market: these are liquid fixed income assets, which are much safer investments than the illiquid variety of fixed income assets. Again note, however, the duration risk that may be present in a long-duration bond (see below).


Historically, interest rates in the range of 5% – 6% have been considered normal. This interest rate range provided for stability of the global financial system for a very long time.

But following the Global Financial Crisis of 2008, the Federal Reserve (and other central banks) lowered interest rates charged to banks and non-bank financial entities (such as hedge funds) to 0%. This caused a 10+year asset-buying spree by hedge funds and private equity funds. Additionally, corporations used low interest rates to borrow money used to fuel stock buyback plans that pushed stock prices higher and higher.

Most often, hedge and PE funds borrowed money in the short term markets (money markets and the repo market), while investing in long-term projects. And this investing strategy, assuming low interest rates would last in perpetuity, created a built-in financial crisis for that day if, and when, hedge and PE funds would need to start borrowing at higher rates to make interest payments on long term payment obligations using short-term borrowed funds; and corporations could no longer justify borrowing money for stock buybacks.

The day of higher interest rates has arrived.

Since 2022, the Federal Reserve has raised interest rates to the current level of 4% to 5%. These rates make the borrow-short / invest-long hedge fund and PE fund strategies unsustainable, since fund business plans assume a much lower interest rate for borrowing money to make interest payments on long-term obligations.


As long as interest rates are low, duration is of minimal risk to pension plans, for the reasons explained immediately above: In a low interest environment, hedge and PE funds can borrow money in the short term markets (money markets and the repo market), while investing in long-duration projects.

And as long as interest rates remained low, duration of the investments hardly mattered. Bonds matching retirement dates became popular–and made sense. It was logical to purchase long bonds to match expected retirement dates–until it wasn’t. The first crack in this strategy became obvious in the UK pension crisis of September 2022. The pension funds held long-duration investments at a low rate, while market interest rates, and bond yields, turned higher. This immediately lowered fair market value of UK gilts (bonds), creating an enormous pension shortfall.

But today, market interest rates have gone from near-zero to the 5% range. In turn, bond yields have risen, which has caused the prevent value of existing bonds to fall.  So, even though treasuries and corporate bonds were highly liquid in a low-rate environment, those same bonds became dangerously under water because of high interest rates.

So, even though traditional government and corporate bonds are theoretically “liquid” in a high-rate environment, bond values on older long-duration bonds can drop so considerably that they are, for all intents and purposes, “illiquid.”


An important consideration in understanding a plan’s risk factors is leverage. Leverage accelerates growth in a bull market, but also accelerates a value decline in a volatile or falling market. Leverage clearly helped grow asset values in the past ten years, where financial markets experienced substantial upswing. But leverage in this current market is a destructive force. As losses occur, leverage punctuates the decline in value.

So, leverage cannot be applied indiscriminately–it is a tool that must fit the circumstances of the existing financial markets. Unfortunately, many plan assets are committed to investing strategies that deploy high leverage.  For example, many hedge funds lever trades to an incredibly high ratio of 50:1. On the other end of the spectrum, mutual funds are restricted by law to apply leverage only 1/3 of the value of the asset fund.

When diversifying in order to avoid the risk of large losses, minimizing leverage is a great place to start.


An important consideration in understanding a plan’s risk factors is withdrawal restrictions and penalties — that are now commonplace. It is common for a plan to be invested in long-term bonds that cannot be transferred to another asset type except at designated withdrawal dates, or with significant withdrawal penalties. Withdrawal limits can be though of as a different version of duration risk. Even if assets have Level 1 liquidity characteristics, if withdrawal limits minimize any withdrawals, you are forced into a longer duration hold than you may expect.

Needless to say, committing to a long-term investing portfolio in a volatile market carries its own risk. But it is important to understand that any long-term investment with withdrawal limitations poses a liquidity risk to your pension plan.


Why do so many pension plans have heavy investments in illiquid assets in collective investment trust structures?

It’s easy to see who benefits: the plan managers and investment advisors who have far greater income potential by maximizing illiquid plan investments. This is because illiquid assets are exceedingly complex, allowing for many obfuscations that, in turn, maximize an investment manager’s opportunity for high fees and carried interest accruals.


Active investing is absolutely the best approach to plan management–but only if the investing strategy is designed to throw out underperforming assets and minimize the risk of large losses.

As a plan participant, it is your right to understand the motives of your plan advisors and fiduciaries, and act accordingly, based on your own best judgment, possessing all the salient facts as to why certain investments were chosen.


Pension risk is a structural set of risk factors that can set your plan up for success in the long term. If pension risk is properly accounted for, the daily impulse of market risk will be survivable.

Pension risk is not just a function of one thing; rather, it depends on a multi-factor risk profile that plays out with different variations in any given market situation.

Liquidity risk must all be systematically evaluated–and acted upon–to achieve and sustain long-term gains.


Alternative Pension Investments

What are alternative investments in a pension plan?

Alternative investments are investments in non-standard assets like cryptocurrencies, hedge funds, private equity funds and complex products.

A distinguishing feature of alternative assets is the valuation method.  Importantly, alternative assets typically do not have a readily available trading market and are therefore valued at “net asset value.”

Compare this to “standard” investments held in pension plans, such as stocks, bonds and mutual funds that are bought and sold at an established “fair market value” on a public securities market.

What’s the difference between “fair market value” and “net asset value," and why should I care?

For assets valued at “fair market value,” the current asset value can be readily determined at least daily, as published by a stock ticker on a public securities market (such as NYSE).

But for assets valued at “net asset value,” the current asset value is not published on a public securities market and must be approximated from book value, or some other valuation method the pension plan’s board establishes “in good faith.”

Therefore, net assete value is inherently less reliable than fair market value, and the valuation process takes longer. So, 401(k) plan investors needing to access cash from plan assets may face a difficult time accessing the actual current value of their plan assets if valued at net asset value than if valued at fair market value.

Are alternative investments safe?

Alternative investment assets are more risky than standard assets (such as mutual funds).

But each 401(k) investor has his or her own risk profile. Therefore, alternative assets are neither “bad” nor “good.” It all depends on market conditions and the investor’s desired risk profile.

In a stable or rising stock market, the risk inherent in alternative investments is relatively low. “A rising tide lifts all boats,” as the saying goes.

But in a volatile or falling stock market, alternative investments may underperform and cause liquidity problems that will make it difficult to withdraw your money when you need it.

The important thing is to understand the risk profile of the investment assets held in your 401k plan, so you can make an informed decision.


Collective Investment Trust

What is a Collective Investment Trust in a pension plan?

A Collective Investment Trust (“CIT”) is entity that pools pension money from multiple different pension plans, and then buys investment assets in the name of the trust. Each contributing pension plan holds a beneficial interest in its share of the pooled CIT assets.

Who Owns a Collective Investment Trust?

A Collective Investment Trust is typically held in the name of a large bank as trustee for multiple pension plans (the beneficiaries of the trust) that have pooled their pension money in the trust.

The most prominent large banks that actively provide Collective Investment Trusts access and management services to pension plans are JP Morgan, Citibank, Wells Fargo and Bank of New York Mellon.

Is the Trustee (Bank) of a Collective Investment Trust Directly Responsible to Individual Pension Plan Participants?

Typically, no. The large banks that own Collective Investment Trusts are not held directly accountable to plan participants in a pension plan.

Who is Responsible to Plan Participants for Investments in Collective Investment Trust?

The ERISA Fiduciaries of a pension plan must answser to plan participants. An ERISA fiduciary must do two things:

First, the Fiduciary must regularly review the investment options offered in a 401(k) plan and must remove under-performing investments. In a volatile or falling stock market, Collective Investment Trusts are likely to underperform, since they typically lack liquidity. This was the problem in the 2022 UK pension plan crisis–book value of investments remained high, but the investments could not be readily converted to cash.

Second, the Fiduciary must explain the Collective Investment Trust to plan participants in plain English, so that the participant can make an informed choice to include the CIT, or not, in his or her own 401(k) plan.

What Type of Assets are Typically Held in a Collective Investment Trust?

It is common for Collective Investment Trusts to hold high-risk assets in alternative investments such as cryptocurrencies, hedge funds, structured notes and other complex products.