Although the prudent man rule employed by most states prior to the passage of ERISA offered a more flexible approach to investment selection than the legal lists, it was rigidly interpreted by the courts. Their interpretation of the rule conflicted with three important principles of modern investment practice: (1) It focused on the performance of the individual securities, rather than on the performance of the portfolio as a whole; (2) it gave short shrift to diversification as an investment strategy of investment objective; and (3) it emphasized avoidance of capital at any cost, instead of evaluating returns relative to risks incurred.

Although the language incorporated in ERISA is strikingly similar to the prudent man rule in common law, Congress did not swallow the common law whole. ERISA replaces the prudent man in his personal affairs with a prudent expert in pension fund management, urging the fiduciary to employ investment practices that a man “acting in a like capacity and familiar with like such manners would use in the conduct of an enterprise of like character with like aims.” By establishing the prudent expert standard, ERISA has opened the door to modern investment practice.

Because most investment experts view their selection decisions in terms of the whole portfolio, for example, ERISA should permit pension managers to adopt that viewpoint. One key principle of portfolio theory is that, through diversification, a money manager can reduce the aggregate risk of a portfolio without lowering its total return. This approach to risk obviously goes beyond ERISA’s injunction “to minimize the risk of large losses.” On the other hand, the conference report accompanying the Act explicitly directs pension managers to adopt diversification policies responsive to the financial objectives and constraints of their pension plans.