The DOL’s proposed regulation on selecting investments, including alternative assets, 2026-06178.pdf, identifies six factors that need to 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 the six factors and provides 20 examples to illustrate their application.

My last three posts have discussed the first factor, Performance, and the two DOL examples of compliance with that factor. (See Alternative Assets (6), Alternative Assets (7) and Alternative Assets (8)) This article moves on to the second of the six factors: Fees.

The proposed regulation says:

(h) Fees. The plan fiduciary must consider a reasonable number of similar alternatives and determine that the fees and expenses of the designated investment alternative are appropriate, taking into account its risk-adjusted expected returns and any other value the designated investment alternative brings to furthering the purposes of the plan. For this purpose, the term ‘‘value’’ includes any benefits, features, or services other than risk-adjusted returns. Section 404(a)(1)(B) of ERISA and paragraph (h) of this section are not violated solely because the fiduciary does not select the alternative with the lowest fees and expenses from among the alternatives considered. For example, a prudent plan fiduciary could choose to pay more in exchange for greater services. [The bolding is mine throughout this article and all of fhe article quoting the proposal]

Comment: Of the six factors, current practices are probably the most closely aligned with the DOL’s expectations about the evaluation of fees and costs. That is due in part to the laser focus on fees and expenses of investments and service providers by plan sponsors and advisors, which in turn is due in part to the focus on fees and costs by plaintiffs’ attorneys in ERISA fiduciary breach litigation.

The one area where the DOL expectation differs from common private sector practices—particularly for small and mid-sized plans—is its requirement to use “risk-adjusted expected returns”.   Over the years I have reviewed a significant number of investment policy statements and attended many plan committee meetings and, as best as I can recall, the discussions were about “raw”, or actual, returns, and not about risk-adjusted returns. In that regard, it is important to know that the quoted language is part of the rule and not an example.  As a result, it could “force” the private sector to primarily use risk-adjusted returns…if the rule is finalized as is. In my view, that would be a mistake, in the sense that the DOL appears to be trying to solve a problem that doesn’t exist…in other words, a solution in search of a problem.

One other quibble…the Fee discussion refers to looking at “a reasonable number of similar alternatives”.  Several examples suggest that a reasonable number is three to five investments.  For fee purposes, I don’t think that works.  If the fiduciaries look at five expensive funds, the information is meaningless.  They are all unreasonable and the resulting information is unreasonable. Fortunately, the common practice is to look at a very large number of similar alternatives and to compare the costs of the investments being considered to the statistically valid data that is derived from a large database of comparable investments.

Since I criticize, I should also compliment.  It is appropriate and helpful for the DOL to provide clear guidance that the issue is value for cost or, in other words, fiduciaries should get reasonable value for the investments and services they acquire for the plan and fiduciaries can pay more for additional value.

While I am not an investment expert, and this should not be viewed as an investment opinion on my part, if fiduciaries can obtain greater returns or less risk by selecting a target date series that includes private funds (yes, illiquid and hard to value, in addition to being more expensive), and the fiduciaries determine that the anticipated additional returns or risk reduction would materially benefit their participants, it is reasonable and prudent to select that target date series.  Of course, the additional value would need to be proportionate to the cost.

Realistically, though, it would be hard, maybe impossible, for most plan fiduciaries to do that without expert help…at the least by a nondiscretionary investment adviser (a so-called 3(21) fiduciary adviser).  If I were a responsible plan fiduciary, I would probably go beyond that and hire a discretionary investment manager (a 3(38) fiduciary adviser) and assign the task of evaluating the factors to the 3(38).  Of course, in doing that, I would have to make sure that the adviser was experienced and competent to make decisions about alternative assets.

As a final comment, I think the DOL made a mistake in drafting the discussion of this factor.   The discussion—which will become a rule if finalized as is—says that the fiduciaries must “determine that the fees and expenses of the designated investment alternative are appropriate”.  That seems, at least to me, to conflict with the position elsewhere in the proposal that, if fiduciaries appropriately investigate a factor, the decision will be presumed to be prudent.  In this case, though, the rule seems to say that the decision itself must also be prudent (i.e., “determine that the fees and expenses…are appropriate”).

The preamble also discusses the Fee factor but that discussion doesn’t really add to the proposed rule:

6. Fees

6.1. The Standard

Paragraph (h) of the proposed regulation identifies fees as a factor for fiduciary consideration in selecting designated investment alternatives. It provides that the fiduciary must objectively, thoroughly, and analytically consider a reasonable number of similar alternatives and determine that the fees and expenses of the designated investment alternative are appropriate, taking into account its risk-adjusted expected returns, net of fees and expenses, and any other value the designated investment alternative brings to furthering the purposes of the plan. For this purpose, the term ‘‘value’’ includes any benefits, features, or services other than risk-adjusted returns net of fees. Proposed paragraph (h) further provides that section 404(a)(1)(B) of ERISA and paragraph (h) of the proposal are not violated solely because the fiduciary does not select the alternative with the lowest fees and expenses from among the reasonable number of alternatives considered. For example, a prudent fiduciary could choose to pay more in exchange for greater services.

Concluding Thoughts

Of all of the six identified factors, the fee factor comes the closest to alignment with current practices. As a result, it should cause little, if any, disruption.  Even there, though, it would be helpful if the final rule deletes the reference to risk-adjusted returns and leave that decision to the private sector.  It doesn’t seem appropriate for a government agency to require investment advisers and managers to engage in specific processes when others may be equally valid.  Perhaps the final regulation will make that change.

We now turn to the Fee factor examples, which have their own issues.