The DOL’s proposed regulation on selecting investments, including alternative assets, 2026-06178.pdf, identifies six factors that should be considered in the process of selecting any investments for participant-directed plans, such as 401(k) plans and private sector 403(b) plans. The six factors are: Performance, Fees, Liquidity, Valuation, Performance Benchmark, and Complexity. The proposal describes each of those factors and provides 20 examples of their application.
In earlier posts, I covered three of the factors—Performance, Fees and Complexity, and their examples
I now turn to the Performance Benchmark factor. Here is the DOL’s description of that factor:
(k) Performance benchmark.
The plan fiduciary must appropriately consider and determine that each designated investment alternative has a meaningful benchmark, and compare the risk-adjusted expected returns of the designated investment alternative to the meaningful benchmark. There may be more than one meaningful benchmark for a designated investment alternative, however no single benchmark is a meaningful benchmark for all designated investment alternatives on a plan investment menu. A ‘‘meaningful benchmark’’ is an investment, strategy, index, or other comparator that has similar mandates, strategies, objectives, and risks to the designated investment alternative. The ‘‘risk-adjusted expected returns’’ of the designated investment alternative may be determined based on its historical performance unless it has none, in which case it may be determined based on the historical performance of a different investment with similar mandates, strategies, objectives, and risks and that is not the meaningful benchmark. While a plan fiduciary should identify benchmarks that are as meaningful as possible, there is no presumption or preference against new or innovative designated investment alternative designs. Instead, when considering a new or innovative product design, a fiduciary should seek to identify the best possible comparators to it while also scrutinizing the potential value proposition presented by the new or innovative design.
(The bolding in this article is mine…just to emphasize the points that I consider the most important.)
Comment: Let’s consider the definition of the Performance Benchmark factor by breaking it into component parts. The first part is that each “designated investment alternative” (or DIA) have a “meaningful benchmark”. While everyone reading this article probably knows what a DIA is, just in case someone doesn’t, it is one of the investments that a participant-directed plan, such as almost all 401(k) plans, provides for participant direction; a plan’s DIAs are sometimes referred to as a plan’s investment menu. (The opposite of a DIA is a plan brokerage account or mutual fund window where participants can select from among thousands of investments.)
The second definition issue is, what is a “meaningful benchmark”? Unfortunately, we don’t have much in the way of guidance on that. But it clearly means something more than what most plans do now. A demanding interpretation would be that, if a large cap value fund held 70% large cap value stocks, 20% large cap growth stocks, and 10% small cap stocks, the meaningful benchmark would need to reflect allocations that parallel that. In one of the examples under this factor (that I will discuss in a future post), the DOL seems to indicate that asset allocation funds, such as target date funds, must have benchmarks that reflect their allocations. But we need more guidance from the DOL to understand what this standard demands.
The definition of the factor goes on to say that fiduciaries must “compare the risk-adjusted expected returns of the designated investment alternative to the meaningful benchmark.” I have a hard time understanding this requirement.
(1) Does it mean that the meaningful benchmark is created first and then used to select investments for a plan?
(2) Or does it mean that, when looking at any investment to be considered as a DIA, fiduciaries must have a meaningful benchmark for that potential investment and then project the “risk-adjusted expected returns” for the investment being considered and compare that to the expected returns for the “meaningful benchmark”?
(3) Or is this referring to monitoring investments that are already in the plan?
My thoughts on which of those three is the intention of the DOL: If the latter–(3), why wouldn’t the proposal say that the investment’s prior performance (e.g., in the preceding year) must be compared to the meaningful benchmark? It doesn’t say that, though. To be fair, the DOL’s proposal is about selecting investments, and explicitly is not monitoring them. Instead, it says that the expected future performance (on a risk-adjusted basis) must be compared to the meaningful benchmark. So, 3 isn’t the answer.
By the way, in earlier posts I discussed the first factor, Performance, which says that, in selecting investments fiduciaries must consider future risk-adjusted performance. So that is already part of the equation.
I don’t think #2 is the meaning either. While it could make sense that fiduciaries would need to compare a particular type of investment (e.g., large cap value funds) to a benchmark or index for large cap value funds, I think the DOL intent is to tie the Performance factor to the Performance Benchmark factor. Also, I think the DOL’s goal is to go beyond generic benchmarks and require something more individualized.
That leaves scenario 3. In other words, I think the DOL expects fiduciaries to, when selecting investments for a plan’s menu, to have an individualized Performance Benchmark to each investment being considered for inclusion in the lineup. (One significant question is, how individualized must the Performance Benchmark be?) An investment’s expected future risk-adjusted would then be compared to the Performance Benchmark’s future expected risk-adjusted return. In my experience, that isn’t consistent with the processes used by most plans and particularly small and mid-sized plans.
The proposal does give some guidance about the “meaningfulness” of the benchmark by saying: “A ‘‘meaningful benchmark’’ is an investment, strategy, index, or other comparator that has similar mandates, strategies, objectives, and risks to the designated investment alternative.” But how similar? For example, are all large cap value mutual funds the same for this purpose, or are there “sub-strategies” that are different enough to require a benchmark other than the common indexes for large cap value funds? The DOL doesn’t tell us. Where there is a void in the guidance, the better legal strategy is to be conservative, but to be conservative we will need more benchmarking indexes, and we will need mutual fund managers and CIT trustees to self-identify to one of those. The best outcome would be for the DOL to provide additional guidance in the preamble to the final regulation.
Finally, the DOL does give us some helpful guidance by saying: “While a plan fiduciary should identify benchmarks that are as meaningful as possible, there is no presumption or preference against new or innovative designated investment alternative designs.” I assume that this was primarily intended for investments that include allocations to alternative assets, such as private funds, it will also be helpful in the development of benchmarks that are responsive to the DOL’s requirement for more individualized benchmarks.
One more comment. The proposed factor says: “The ‘‘risk-adjusted expected returns’’ of the designated investment alternative may be determined based on its historical performance,,,”. That seems to fly in the face of the common disclaimer “Past performance is not indicative of future returns”. Also, if there has been a manager change, is past performance really indicative of future returns? Maybe, but maybe not.
The preamble to the proposed regulation discusses the factor, but doesn’t add more to the discussion.
Concluding Thoughts
My best understanding is that the DOL expects, as an investment is being considered for inclusion in the plan’s lineup as a DIA, fiduciaries must (1) determine its expected future risk-adjusted returns under the Performance factor discussed in an earlier post, (2) develop a meaningful benchmark of expected future risk-adjusted returns for the benchmark under this factor—the Performance Benchmark, and then (3) compare the expected future risk-adjusted returns of the investment to the future expected risk-adjusted returns of the meaningful benchmark.
Hopefully, the DOL will provide more detailed guidance when it issues the final regulation.
