This article continues the discussion of the DOL’s Performance Benchmark factor by reviewing the third 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 (20), discussed the second example under the Performance Benchmark factor—about asset allocation investments with allocations to private funds.  Here is the DOL’s third and final example of the application of that factor—which illustrate the application of the factor to a target date fund that only holds publicly traded securities:

(3) Example. Custom composite benchmark; Public securities—

(i) Facts. The named fiduciary for a participant-directed individual account plan selects a target date fund as a designated investment alternative. The target date fund holds only publicly traded stocks and bonds. As part of the selection process, the fiduciary appropriately considers whether a particular custom composite benchmark is a meaningful benchmark. The custom composite benchmark is a blend of broad-based securities market indices. The blend represents the asset allocation used to implement the target date fund’s strategy. The named fiduciary reads, critically reviews and understands the benchmark description and determines that the custom composite benchmark is a meaningful benchmark. The named fiduciary compares the historical performance of the target date fund to the historical returns of the custom composite benchmark as a means of evaluating the risk-adjusted expected returns of the target date fund.

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

Comment: The fact situation sets the stage for the application of the proposed requirement that each investment in the core lineup (or “menu”) of a participant-directed plan have a “meaningful” benchmark.  The meaningful benchmark is intended to be a true comparator to the investment.  This example is about a target date fund, which will be one of the most difficult investments to benchmark. The Facts are that the fiduciary has been given a “custom composite benchmark”, presumably either by the investment manager or by a plan advisor/consultant. The benchmark is “a blend of broad-based securities market indices”.  A logical question at this point is, how specific must the benchmark be, both in terms of the indices for the types of investments underlying the TDF and in terms of the percentage allocations.  Is it enough to have one for the allocations to stocks and a second for bonds…or does it have to be more detailed than that.

The next sentence in the Facts sets the stage for answering the question…”The blend represents the asset allocation used to implement the target date fund’s strategy.” As I interpret that language, the DOL’s expectation is that there be an index for each asset class and investment style, for example, if the TDF allocates 10% to small cap growth, then the benchmark would have a 10% allocation to a small cap growth index. (Spoiler alert…the DOL’s Analysis, immediately following this discussion, confirms my reading.)

The Facts go on to say that the fiduciary reviews and understands the custom benchmark and determines that it is, indeed, “meaningful”. The fiduciary then compares the historical performances of the target date fund and the meaningful benchmark and evaluates the target date fund on that basis.

I assume that plan advisers and fiduciaries have been using some benchmarks as a part of the fiduciary process for selecting target date funds. But I think that the need to use a customized meaningful benchmark will be new to that process.

To be complete, the proposal doesn’t require that a meaningful benchmark be used in order for a process to be prudent, but instead provides a presumption of prudence if one is used.  However, there is a real risk that, once the regulation becomes final, a fiduciary who does not use a meaningful benchmark could be seen as imprudent.  Think about it. How can you evaluate past performance of an investment without a benchmark that is appropriate, or “meaningful”, for that investment?

(ii) Analysis. In determining whether a particular benchmark is a meaningful benchmark with respect to a designated investment alternative, plan fiduciaries may rely on benchmarks that blend multiple broad-based securities market indices to represent the asset allocation used to implement the target date fund’s strategy. Plan fiduciaries should review and understand the benchmark description or consult with an investment professional, as appropriate. The custom composite benchmark outperformed or underperformed the benchmark in each asset class, providing valuable information to the plan fiduciary about the fund’s investment selection decisions.

Comment: As I read it, the statement that meaningful benchmarks should “blend multiple broad-based securities market indices to represent the asset allocation used to implement the target date fund’s strategy” means that the allocations to investment categories by the target date fund should have corresponding allocations to indices in the benchmark.  I don’t see any way to get around that based on the language in the Analysis.

I am also really interested in the statement that “The custom composite benchmark outperformed or underperformed the benchmark in each asset class, providing valuable information to the plan fiduciary about the fund’s investment selection decisions.”  I don’t think there is any way to read this other than to say that the DOL expects fiduciaries to look at the performance of each component of a target date fund and understand where the underlying investments are underperforming or outperforming.  For example, if a target date fund has allocations to 10 underlying mutual funds, there would need to be corresponding indices (in the same allocations) for the 10 mutual funds and fiduciaries would need to review and compare performance for all ten.  That is a clear departure from current practices with the exception of the largest plans that have custom target date funds.

(iii) Conclusion. The plan fiduciary in this example satisfies this paragraph (k) and ERISA section 404(a)(1)(B) by considering and determining within its discretion 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.

Comment: The good news is that, after all that effort, the DOL says that the plan fiduciaries did their job properly. But the DOL summarizes a two-step process:

• The fiduciary had to consider and determine that the target date fund had a meaningful benchmark, and
• The fiduciary needed to compare the risk-adjusted expected returns of the target date fund with the meaningful benchmark.

With regard to part of the second point, I think the DOL made a mistake.  In its statement of the Facts of this example, the DOL said that the historical returns on the investment and the benchmark needed to be compared.  Here it says that the “expected” returns need to be compared.  However, nowhere in this example does it say that the meaningful benchmark is to be based on expected future returns (or, for that matter, that the indices are to be adjusted for risk).  Since the purpose of the proposed regulation is to help with the selection of investments (and not monitoring), I think the DOL needs to clarify whether it is the historical or expected returns of the investment and of the meaningful benchmark that need to be compared for purposes of obtaining the relief provided by the regulation.  It seems to me that the real requirement for the selection of investments is whether the fiduciaries need to determine that the investment is likely to continue to perform well in the future.  I say that because (1) I don’t think it is realistic to project future performance on an index, and (2) the historical performance of an investment and a corresponding index is informative, but not determinative.  Other factors are at play, for example, has there been manager turnover or other disruption at the investment manager.

The preamble discusses this example as follows:

Paragraph (k)(3) of the proposed regulation provides a positive example of a named fiduciary using a custom composite benchmark to select as a designated investment alternative a target date fund that holds only publicly traded stocks and bonds. The custom composite benchmark is a blend of broad-based securities market indices, which blend represents the asset allocation used to implement the target date fund’s strategy. The named fiduciary reads, critically reviews and understands the benchmark description. The named fiduciary compares the historical performance of the target date fund to the historical returns of the custom composite benchmark as a means of evaluating the risk-adjusted expected returns, net of fees, of the target date fund.

The named fiduciary in this example satisfies the requirements of ERISA section 404(a)(1)(B) and paragraph (k) of the proposed regulation by analytically, thoroughly, and objectively considering and determining within its discretion that the designated investment alternative has a meaningful benchmark which shares similar traits, including mandates, strategies, objectives, and risks, and comparing the risk-adjusted expected returns, net of fees, between the designated investment alternative and the benchmark. This example illustrates the principle that plan fiduciaries may, if appropriate under the circumstances because the fiduciary reviewed and understood the benchmark and because the custom composite shares similar traits with the designated investment alternative, rely on benchmarks that blend multiple broad-based securities market indices to represent the asset allocation used to implement the target date fund’s strategy.

Comment: The bolded language is additional support for the conclusion that the DOL expects the meaningful benchmarks to be individualized, at a detailed level, to the investment.  Beyond that, I expect that, in due course, those meaningful benchmarks will be used for monitoring (and that the DOL will say so).  In that case, just imagine the problems if the benchmarks aren’t similar, in all regards, to the investment.

Concluding Thoughts

Unless the DOL later issues contradictory guidance, e.g., in the final regulation, and I don’t expect that it will, meaningful benchmarks will be a heavy lift.  I assume that the investment industry data providers will support advisers and plan sponsors—at least for the more widely held investments. But advisers and plan fiduciaries will need to “analytically, thoroughly, and objectively” review the benchmarks and determine that they are meaningful.

The meaningful benchmarks will initially be used for the selection of investments.  After that, they will almost certainly need to be used for monitoring investments in the plan’s menu.