Are Your 401(k) Plan & Fund Benchmarks Valid?

It’s crazy to think about, but quite often investment benchmarks are simply assumed to be correct.  I recently saw a set of target date suite funds benchmarked to the S&P 500, and this was done by the fund family.  Okay – so I am not going to mention any names here, but … that is truly ridiculous.  

Target Date Funds are actively managed asset allocation investments.  The S&P 500 is an index that measures the value of the stocks of the largest 500 stocks (based on market capitalization) in the New York Stock Exchange.  This is like comparing elephants to eagles because they are both living creatures.The standards for benchmarking are well defined by the CFA Institute in their Global Investment Performance Standards (GIPS).

According to GIPS, investment strategies generally fall into one of three categories: 

1. Benchmark Relative: In this category, investment decisions are made relative to benchmark weights, exposures, and risks. The portfolio may be very similar to the benchmark in this instance (e.g., passive and active index strategies). 

2. Benchmark Aware: In this category, benchmark relativity is observed or the benchmark serves as an investable universe. Generally, there will be distinct differences between the portfolio and the benchmark (e.g., concentrated strategies). 

3. Benchmark Neutral: In this category, benchmarks are treated more as target returns or hurdles to beat or there is no appropriate benchmark. This is common with absolute return and alternative strategies and for strategies not covered by index providers. In these instances, a predefined target return that is not based on a market index may be used.

In the retirement plan fund evaluation space, “Benchmark Relative” is most common.  Target Date Funds should be benchmarked to similar fund types … not the S&P 500 Index.  This holds true with many other asset classes, and the purpose of this communication is to get plan committee members to pay close attention to benchmarks.  

If benchmarks are incorrect, then funds may get removed or added to the plan for the wrong reasons, and that can lead to poor plan performance.  Here is an article on the differences between types of bond funds. This is an issue that we addressed at Veriphy Analytics for the last three years.  Morningstar recently bifurcated bond funds into two asset categories instead of one. That is an excellent change and the article explains why.


Feel free to reach out to me with any questions or comments.  

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