This article continues the discussion of the DOL’s Performance Benchmark factor by reviewing the first example of the application of that factor.

As background, 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.

My last post, Alternative Assets (18), discussed the Performance Benchmark factor.  Here is the DOL’s first example of the application of that factor:

(1) Example. Benchmark; Misalignment of strategies—

(i) Facts. A participant-directed individual account plan offers a designated investment alternative that is a target date fund with an investment strategy and long-term objective of investing in different asset classes with varying degrees of risk, and which gradually becomes more conservative over time by adjusting the mix of asset classes. To compare the risk-adjusted expected returns of the target date fund to a meaningful benchmark, the named fiduciary compares the returns to a benchmark that is an index that only tracks the returns of large capitalization U.S. equities even though other benchmarks with more similarities to the designated investment alternative were readily available.

(The bolding in this article is mine…just to emphasize the points that I consider the most important.)

Comment: For the sake of discussion, let’s assume that the benchmark being used by the plan is the S&P 500 index. And let’s also assume that it is being used for all vintages ranging from, e.g., the 2025 TDF to the 2065 TDF. Then assume that the 2065 TDF is allocated 90% to a range of domestic and international equity funds and 10% to fixed income funds.  On the other hand, assume that the 2025 fund is 40% equities and 60% fixed income.

Ask yourself, is it meaningful to benchmark either against the S&P 500 index? Obviously, I have an opinion on that, but I’m a lawyer and not an investment advisor. But if the S&P 500 index isn’t a true comparator, it shouldn’t be used…in the DOL’s view. Think about it.  If the S&P 500 index were a true comparator, then you should be able to reasonably benchmark the performance of the 2025 fund against it.  Obviously, that isn’t reasonable.

(ii) Analysis. Paragraph (k) of this section provides that a ‘‘meaningful benchmark’’ is an investment, strategy, index, or other comparator that has similar mandates, strategies, objectives, and risks to the designated investment alternative.

Comment: Again, ask yourself if the S&P 500 index has the mandates, strategies, objectives and risks similar to TDFs along the range of the target dates. It doesn’t and we all know that.

(iii) Conclusion. The facts in this example do not establish that the named fiduciary satisfied section 404(a)(1)(B) of ERISA and paragraph (k) of this section when selecting the designated investment alternative because the strategies of the benchmark are not similar to the investment strategy of the target-date fund and other benchmarks with more similarities were readily available.

Comment: No surprise here.  The DOL intends that the meaningful benchmark will be a true comparator and, as I think about it, there will probably need to be a true comparator for each vintage of the TDF suite (as well as for all other DIAs in a plan menu). While the DOL doesn’t say it, I think that the intent is that fiduciaries can use the meaningful benchmarks as comparators for evaluating future performance of the investment.  The proposal explicitly says that the rules are for selection of investments, and not for monitoring, but I think that they will be used for comparing actual to benchmark performance and, almost certainly, plaintiffs’ attorneys will use them in that way.

The preamble discusses this first example as follows:

Paragraph (k)(1) of the proposed regulation provides an example of a performance benchmark for a designated investment alternative that is a target date fund. The target date fund’s strategy and objective involve investing in asset classes that change over time, with different degrees of risk, gradually becoming more conservative over time. The example concludes that the plan fiduciary’s use of a benchmark that is an index that tracks the returns of large capitalization U.S. equities (when a more similar potential benchmark was available) would not establish that the fiduciary satisfied the requirements of paragraph (k) of the proposed regulation. A large capitalization index is not a meaningful comparator because it tracks different securities than the target date fund holds. Furthermore, the large capitalization index only adjusts its constituents over time due to changes in the constituent securities’ market capitalizations, rather than based on the years until a particular date, as a target date fund does. This example illustrates the principle that a performance benchmark must be a meaningful comparator by sharing similar traits, including mandates, strategies, objectives, and risks to the designated investment alternative.

Comment: The preamble discussion points out that the large cap index of domestic stocks tracks different mix of securities than those that TDFs hold. That probably refers to equities versus mixed holdings of equities and fixed income, and also to the different capitalizations of the underlying companies, as well as other differences.  Interestingly, the discussion also points out that the index is static in the sense that it does not automatically change allocations over time while TDFs do.

Concluding Thoughts

This example is, in my view, “vanilla”.  The outcome seems obvious once you accept that the benchmark must be meaningful and must be a comparator.  But there is still an issue of “how similar” must the benchmark be to the investment?  That’s not clear, but I suspect that, for TDFs (and possibly other investments) the benchmarks will need to be much more similar than current practices.

For example, would it be enough to allocate TDF suites to benchmarks for conservative allocations and glide paths, moderate and aggressive?  I don’t think so. And frankly I don’t see how you can benchmark the whole suite against a single benchmark that is meaningful.  I think it will need to be targeted date by targeted date.

More to come.

My next article will add some to your knowledge of what the DOL intends with its meaningful benchmark factor.