This article continues the discussion of the DOL’s Performance Benchmark factor by reviewing the second 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 (19), discussed the first example under the Performance Benchmark factor. Here is the DOL’s second example of the application of that factor:
(2) Example. Custom composite benchmark; Private equity sleeve—
(i) Facts. The named fiduciary of a participant-directed individual account plan selects as a designated investment alternative an asset allocation fund, which is registered under the Investment Company Act of 1940, that contains a private equity sleeve in addition to publicly traded stocks and bonds. In making this selection, the named fiduciary prudently enlists the assistance of an investment advice fiduciary within the meaning of section 3(21)(A)(ii) of ERISA. The investment advice fiduciary, who has no affiliation with the asset allocation fund, recommends the designated investment after creating a composite benchmark against which to measure risk-adjusted expected returns of the sleeves of the designated investment alternative. For the publicly traded stock and bond sleeves, the composite benchmark blends the performance of broad-based securities market indices reflective of and in proportion to the stock and bond holdings of the designated investment alternative. For the private equity sleeve, the investment advice fiduciary uses a combination of methodologies commonly used by investment professionals, including the internal rate of return method and a public market equivalent method, and presents these measures with explanations of how to interpret them to monitor the designated investment alternative’s performance over time. The investment advice fiduciary also provides the named fiduciary with a written explanation of the composite benchmark. The named fiduciary reads, critically reviews, and understands the written explanation, and does not know, or have reason to know, other information which would cause the named fiduciary to question the written explanation.
(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 asset allocation fund is a target date fund and it holds allocations to private equity and private credit funds.
The DOL’s position is that the “meaningful benchmark” for the publicly traded stock and bond allocations can be a “blend” of broad-based securities market indices. However, the DOL goes on to suggest that the benchmark can or should be used to monitor the investment over time. Does that mean that the allocation to large caps stocks could be the S&P 500 index and the allocation to small and mid-cap stocks should be appropriate indices for those investments? Or can a total stock market index be used for all combined securities? Or just for US securities and another index would be needed for international equities? The DOL doesn’t say what it expects. As a result, the private sector is left to guess at the DOL’s intent. In that case, conservatism is the safer approach and conservatism would mean that the allocations in the benchmark should be by percentages to each asset class and investment style that correspond to the allocations in the target date fund. Large to large, mid to mid, small to small, value to value, blend to blend, growth to growth, domestic to domestic, international developed to international developed and so on. If that is the intent, it would be a significant change from current practices, particularly for mid-sized and smaller plans. Since that would be a significant change, the DOL’s guidance should be explicit.
On the other hand (I’m a lawyer and therefore licensed to have other legal hands), it wouldn’t make much sense to have a “meaningful” benchmark that wasn’t useful for monitoring the performance of the covered investment, that is, where the actual performance of the fund should be about the same as the benchmark.
(ii) Analysis. The named fiduciary must ensure that its decision is based on a meaningful benchmark. In determining whether a particular benchmark is a meaningful benchmark, a named fiduciary may rely on a benchmark created by a prudently selected investment advice fiduciary that is independent of the manager of the designated investment alternative. A named fiduciary need not be more expert in benchmark construction and analytics than the investment advice expert hired by the named fiduciary to assist in the selection process.
Comment: The Analysis makes clear that a plan’s primary investment fiduciary must create or adopt a meaningful benchmark. The primary fiduciary could be the plan sponsor (e.g., acting as a plan committee) or a 3(38) investment manager. Whichever it is, that is who has the fiduciary responsibility for ensuring that there are meaningful benchmarks. My suspicion is that investment providers will help with that job by providing benchmarks that they think will satisfy the requirements. However, the primary investment fiduciary will still have the responsibility to ensure that the benchmarks are truly meaningful (and then using them to benchmark performance as part of the investment monitoring.)
(iii) Conclusion. The named fiduciary in this example satisfies this paragraph (k) and ERISA section 404(a)(1)(B) by considering and determining that the designated investment alternative has a meaningful benchmark and comparing the risk-adjusted expected returns of the designated investment alternative to the meaningful benchmark. The composite benchmark reflects the strategies and proportions of the underlying assets of the designated investment alternative. The named fiduciary read, critically reviewed, and understood the investment advice fiduciary’s explanation of the composite benchmark.
Comment: Two thoughts about the Conclusion. First, the language about the composite benchmark suggests something that is fairly individualized to the actual allocations in the investment. That tilts towards the more detailed use of indices that I described earlier in this article. Second, the DOL acknowledges that the primary investment fiduciary can satisfy this requirement by working with an investment adviser. Even there, though, the primary fiduciary must review, understand and adopt the recommendation as its own. Blind reliance will not support fiduciary compliance.
The preamble discusses this example as follows:
Paragraph (k)(2) of the proposed regulation contains an example of a performance benchmark for a designated investment alternative that is an asset allocation fund, and which contains a private equity sleeve, as well as publicly traded stocks and bonds. In the example, a prudently selected investment advice fiduciary within the meaning of ERISA section 3(21)(A)(ii), who has no affiliation with the asset allocation fund, recommended the designated investment alternative after creating a composite benchmark measuring risk-adjusted expected returns, net of fees, of the two sleeves of the designated investment alternative. For the stock and bond sleeves, the composite blends the performance of broad-based securities market indices relative of and in proportion to the stock and bond holdings of the designated investment alternative. For the private equity sleeve, it uses a combination of methodologies commonly used by investment professionals, including the internal rate of return method and a public market equivalent method (presented with explanations of how to interpret them). The investment advice fiduciary in this example also provides the named fiduciary with a written explanation of the composite benchmark, which the named fiduciary reads, critically reviews, and understands. The plan fiduciary in this example satisfies paragraph (k) of the proposed regulation and ERISA section 404(a)(1)(B) because it objectively, thoroughly, and analytically considered and determined that the designated investment alternative has a meaningful benchmark and then compared the risk-adjusted expected returns, net of fees, of the designated investment alternative to the meaningful benchmark. The composite benchmark reflects the strategies and proportions of the underlying assets of the designated investment alternative. The named fiduciary read, critically reviewed, and understood the investment advice fiduciary’s explanation of the composite benchmark. This example illustrates the principle that a named fiduciary, including in the context of the selection of an asset allocation fund which includes a sleeve of alternative assets, may rely on the expertise of an investment advice fiduciary in benchmark construction and analytics, so long as it reads, critically reviews, and understands the investment advice fiduciary’s explanation.
Comment: The interesting apart of the preamble discussion is what the DOL chose to emphasize. In the preamble, the DOL twice stated that the primary investment fiduciary (the plan sponsor in this case) “reads, critically reviews, and understands” the adviser’s recommendations and report. Forewarned is forearmed. Fiduciaries cannot blindly accept recommendations. No matter how competent the adviser is, the fiduciaries must, in effect, understand the basis for the recommendation and adopt the recommendation as their own decision.
Second, the DOL says that the meaningful benchmark, which it refers to as the “composite benchmark”, “reflects the strategies and proportions of the underlying assets of the designated investment alternative”.
Questions for investment folks reading this article. What is a strategy? Is large cap value a strategy as compared to small cap growth? Is investing in US equities a strategy as compared to investing internationally? In other words, what is the DOL saying here?
Concluding Thoughts
If this provision is in the final regulation, and I think it will be, fiduciaries will need to adopt meaningful benchmarks for each investment option in the menu of ERISA-governed, participant-directed plans, such as 401(k) plans and private sector 403(b) plans.
Very few plan sponsors will know how to create and use meaningful benchmarks. As a result, the industry will need to provide them. It will be up to fiduciary investment advisers to determine if the benchmarks are truly meaningful and if their clients—the plan sponsors and committees—can prudently adopt them.
At this point, I don’t think we have enough detail about the DOL’s expectations of the “meaningfulness” of benchmarks, particularly for asset allocation funds. Hopefully, the final regulation will fill in the blanks on that.
Brace yourself. The final regulation could be out and effective in the first quarter of 2027, just months from now.
