Sponsors of 401(k) plans sometimes do not approach the selection of capital market benchmarks as if it has a significant role to play in the implementation of their investment policy statements (IPSs). They may leave benchmark selection to investment managers, consultants, or service providers, but in so doing they may be missing an opportunity to enhance plan oversight and administration.
According to Ian Kopelman, Chair of the Employee Benefits and Executive Compensation Practice at DLA Piper, an IPS of defined contribution retirement plans ought to include several key elements. Among them are the following.
- Describe the purposes and general investment objectives of the plan: Fulfillment of a plan’s purpose is interconnected with its investment objectives, which in turn should be measured against appropriate capital market-based benchmarks. For example, if a plan aspires to provide default investment options that transition from wealth accumulation to income risk mitigation, then such an investment strategy ought to be measured against an appropriate benchmark.
- Describe the asset classes to be offered and the factors for selecting investment options, such as risk/return characteristics, expenses, and benchmark comparisons: Multi-asset class investment products, such as target date and balanced funds, are now the most widely adopted default solutions within 401(k) plans. These products typically have a mandate to deliver full-fledged investment programs that cannot be robustly measured against single asset class benchmarks. It is more important than ever to develop a methodical framework to benchmark selection in light of the dynamic, complex nature of modern default investment alternatives.
- Describe standards for investment performance and criteria for measuring performance: One of the deeper issues around investment performance is benchmark appropriateness. Too often, a great deal of time and energy is spent on performance analytics, but a lack of benchmark due diligence results in flawed analysis. In other words, an IPS can describe standards and criteria for investment performance, but if a selected benchmark is not appropriate for the investment strategy, the analysis is flawed from the outset.
- Describe the process and standards for selecting a qualified default investment alternative (QDIA): No other investment selection has as much potential impact on a plan’s participant population as the QDIA choice. So it is singularly important to select an appropriate benchmark for the QDIA. Within the overall target date category, the S&P Target Date Indices offer industry-wide benchmarks that represent a consensus view of target date managers. S&P DJI offers the static S&P Target Risk Indices that may serve well as benchmarks for balanced funds. For target date income funds, a new category that seeks a transition and a balance between growth and the mitigation of income affordability risk, the S&P STRIDE Indices may serve well as the benchmark of choice.
Far from being merely incidental in the investment monitoring process, benchmarks play a vital role in the implementation of a retirement plan’s IPS. However, for their true value to be realized, a thoughtful approach to benchmark selection is essential.
 See “Investment Policy Statements: Think Art, Not Science” at http://dimensional.com/media/350682/3-Investment-Policy-Statements.pdf