How DC plans can combine the best of active and passive

The traditional paradigm of “active versus passive” investing is increasingly outdated in the defined contribution (DC) industry. Heightened market volatility, extreme index concentration, and acute fee pressures are driving many DC plan sponsors, advisors, and consultants to reevaluate the role of active and passive styles, both in terms of their return potential and the investment experience they provide to participants.

Consequently, a middle range of investment strategies—combining active management with index exposures or other passive attributes—is gaining traction. When thoughtfully designed and skillfully managed, these strategies can align well with plan sponsors’ goals to improve participant outcomes and deliver value for cost.

Why both?

Our latest research finds that more than 3 in 5 (62%) U.S. DC plan sponsors agree with the belief that active management adds value (Fig. 2). An even larger share (70%) supports the use of active management to hedge against downside risk due to market volatility.

Regarding reasons to use passive management, 81% cite lower tracking error, and nearly the same percentage (80%) say that “limiting cost is the most important consideration.”

Taken together, we believe the data show broad recognition that active management can meaningfully influence retirement outcomes and that cost, while important, should not be the sole consideration in investment selections. This perspective is consistent with the Employee Retirement Income Security Act of 1974, or ERISA, which tasks fiduciaries with evaluating value for cost rather than simply choosing the cheapest investment option.

We find that plan sponsors’ emphasis on low tracking error—generally associated with index investing—is often rooted in a desire to limit overall volatility for participants. However, index investing does not necessarily translate to less volatility or less risk. In today’s narrative‑driven market environment, where factor risks loom large, having some flexibility to enhance diversification and manage risk can be especially valuable in helping participants stay invested and progress toward their retirement goals.

Every year counts

Moreover, even small margins of above‑benchmark returns can significantly improve retirement outcomes due to the compounding effect of reinvestment. Our analysis suggests that an additional 25 basis points in excess return over 40 years of savings could result in an additional two years of retirement spending (Fig. 3). Increasing the excess return to 50 basis points could add five additional years of spending. This is particularly meaningful, as outliving savings is among retirement savers’ greatest concerns.¹

A closer look: Examples of “best‑of‑both‑worlds” strategies

Investment strategies that seek to combine the benefits of active and passive styles span a wide range of philosophies, objectives, and implementation methods. These differences lead to various levels of active risk and tracking error and a diversity of industry labels—such as blend, enhanced index, and smart alpha.

Regardless of style or label, we believe these strategies must be able to address an inefficiency in the market and provide solutions that passive‑only strategies simply cannot. Below, we highlight examples of strategies that aim to meet these criteria within equity, fixed income, and target date portfolios (Fig. 4).

#1 Equity: Seeking consistent alpha through a risk‑controlled design

The significant outperformance of U.S. mega‑cap tech companies has driven strong results for the S&P 500 and other cap‑weighted, broad equity market indexes. However, it has also generated extreme levels of index concentration, making it more difficult for active managers to outperform and raising concerns around the inflexibility of passive‑only strategies.

While some large‑cap equity portfolios have delivered above‑benchmark returns in this environment, many have lagged net of fees, and the dispersion in outcomes among fully active, higher tracking error strategies has been notably wide (Fig. 5). This has raised the stakes over manager selection, as DC plans value not only excess return potential, but also consistent performance that supports a smoother participant experience and mitigates sequence‑of‑returns risk.

These challenges have opened the door for a middle path—one that controls active risk and offers consistent excess return potential.

Our Structured Research Equity team, for instance, aims to generate alpha across all market environments through a broadly diversified approach that does not rely on sector or factor bets.

• The team uses rules‑based portfolio construction and risk management to maintain similar sector and industry exposures and portfolio characteristics as its portfolio benchmark, with the goal of isolating stock selection as its main alpha driver.
• From there, the team harnesses analysts’ fundamental insights. Under the oversight of portfolio managers, analysts are empowered to allocate investors' capital in the portfolio, overweighting what they believe are the most attractive companies within their coverage areas and underweighting or avoiding the least attractive. Consequently, analysts’ highest-conviction ideas are emphasized within the portfolio.
• We believe this approach can yield a neutral portfolio, enabling fundamentally driven stock selection—rather than a particular style or subsection of the market—to drive the potential for strong risk‑adjusted results and more consistent excess returns over the long run.

#2 Fixed income: Exploiting benchmark inefficiencies

Unlike equity investing, full index replication in fixed income is virtually impossible given the sheer number of securities held in benchmarks and the liquidity constraints inherent to bonds. Certain issues may not be available to purchase in proportion to their index weight. Others may not trade at all.

Consequently, bond index strategies have some level of tracking error regardless of how they aim to replicate their benchmarks’ performance. New issuance, maturing securities, credit downgrades, and redemptions can also continuously alter the makeup of a fixed income index, potentially increasing tracking error for passive strategies seeking pure index replication (Fig. 6).

These and other inefficiencies create opportunities to replicate the risk factors of popular benchmarks, such as the Bloomberg U.S. Aggregate Bond Index, in a yield‑advantaged manner.

• For example, our QM U.S. Bond portfolio management team believes that benchmark sector imbalances and biases can be exploited through thoughtful portfolio construction.
• The team harnesses quantitative models and tools to build a portfolio that can outyield its benchmark while keeping a benchmark‑consistent risk profile.
• The team complements this portfolio construction approach by leveraging the experience of our fundamental research platform, seeking securities that it believes can minimize downside risk.

#3 Multi‑asset: Building better blends

While offering a meaningfully different investment experience than an index‑like or single‑asset‑class offering, target date strategies are another area where plan sponsors can combine the benefits of active and passive management.

The architecture of target date solutions makes it operationally straightforward to incorporate or “blend” active and passive building blocks within a single product. While they currently represent only 11% of total target date industry assets,² blend products exhibit the fastest growth rate among target date categories (Fig. 7).

Within blend target date strategies, providers differ in how and where they use active and passive vehicles along their glide path and among building blocks. Ultimately, how providers balance lower fees from passive exposures against the potential diversification and return enhancement of active allocations reflects different value propositions.

Research from T. Rowe Price’s Multi‑Asset Division suggests that the relative cost effectiveness of passive and active approaches varies meaningfully across market segments and investment styles.

• Within equity building blocks, our Target Date investment team typically sees core U.S. equities as the most efficient areas for passive allocations. On the other hand, it views a range of style‑ and size‑based segments, such as U.S. small‑cap growth and international large‑cap value, as the best opportunities for excess return potential.

The inherent efficiency of a market segment is another crucial consideration when assigning active and passive approaches across building blocks.

• Our team favors active management in emerging markets equities, as this market segment is generally less efficient and less liquid than developed global market counterparts. Additionally, popular emerging markets indexes tend to be heavily concentrated in just a few countries.
• Universes that do not offer adequate passive alternatives, such as hedged equity and real asset equities, are also better suited for active management.
• Among fixed income building blocks, the team sees better opportunities for passive exposures in core allocations and favors active positions in areas with greater idiosyncratic risks or undesirable benchmark qualities, such as high yield bonds, floating rate loans, and non‑U.S. debt (emerging and developed markets).

Our strengths

Given the complexities of successfully implementing a strategy that employs aspects of both active and passive investing, manager selection becomes especially critical. These strategies demand robust portfolio construction processes, precise risk management, and continuous innovation in both research and implementation.

The ability to generate differentiated insights across sectors and asset classes—and translate them into index‑aware portfolios—requires scale, experience, and collaboration among investment professionals. Managers with global research platforms, strong fundamental analysis, and advanced quantitative capabilities are better positioned to balance these demands.

Equally critical, managers must listen closely to the needs and preferences of plan sponsors when it comes to active risk and be able to embrace evolving demands. As our survey data indicate, DC plans and their consultants and advisors vary in their appetite for active exposure by asset class and investment strategy (Fig. 8).

Ultimately, manager selection is about partnering with teams that possess the depth of resources, discipline, experience, and flexibility to add value for plan participants over full market cycles.

We believe that our longstanding investment research strengths, combined with our data‑driven insights into DC plan sponsor and participant priorities, give us a competitive advantage in designing and managing investment solutions that blend the best of active and passive.

Final thoughts

Active and passive investment styles are increasingly becoming a “both and” rather than an “either or” decision. Strategies that blend these styles can offer compelling benefits for DC plans and their participants, including the potential for better long‑term outcomes through above‑benchmark returns.

 

Appendix: Study methodology

2025 DC Plan Sponsor Retirement Trends Study: Among the respondents in our 2025 study, 71% reported having more than USD 500 million in plan assets, while the other 29% had less than USD 500 million. Respondents described their company’s structure as a corporation or partnership, union, government organization, nonprofit educational institution, or health care or other nonprofit organization or foundation; were involved in any DC retirement plan(s) that either their organization sponsors or they personally advise on; and had a role in overseeing and/or selecting their organization’s DC plan investment offerings. Among the respondents, 58% described their department as finance/investments, 26% as human resources, and 16% as other. Survey respondents were not aware that the research was sponsored by T. Rowe Price, and they are not necessarily T. Rowe Price clients.

2025 Defined Contribution Consultant Study: This study included 45 questions and was conducted from January 13, 2025, to March 10, 2025. Responses are from 36 consulting and advisor firms with over 136,000 DC plan sponsor clients and nearly $9 trillion in assets under administration.