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The Labor Department has the industry all abuzz about ESG (environmental, societal, governance) investments—this week we asked readers about their take on the proposal, and how ESG fits in with their current practice(s).
Late last month, noting its concern “that the growing emphasis on ESG investing may be prompting ERISA plan fiduciaries to make investment decisions for purposes distinct from providing benefits to participants and beneficiaries and defraying reasonable expenses of administering the plan,” the Labor Department proposed a new rule to clarify the standards. Standards, it seems fair to say, that left unamended might be expected to slow interest.
There’s been a lot of response to the Labor Department’s proposal—and yet, 46% of the respondents to this week’s NAPA-Net Reader Poll said that it “makes sense to me.” Just 18% felt that the Labor Department was “way off base,” while 27% “haven’t decided” how they feel about it—and the rest hadn’t yet read it. As one reader explained, “We have not been big proponents of—nor received many client requests for—ESG options. Thus the DOL proposed rule would have minimal impact on our practice & what we are routinely doing—and hence have spent only minimal time reading up on it.”
Practice ‘Says’
The Labor Department’s stance notwithstanding, we asked readers their take on the suitability of ESG options on a defined contribution/401(k) plan menu. On that issue, 45% said “I think it makes sense as a consideration, but not a controlling consideration,” 20% “had their doubts,” 18% were “completely on board!” and 17% were “open to the idea, but not really committed.”
Asked if they were actively recommending ESG options to their clients, just 1 in 10 were. As for the rest:
32% – No
27% – Only when asked about it
22% – To some, in selected circumstances
8% – Not yet
Were plan sponsor clients proactively asking about ESG options?
49% – Some are, most aren’t
35% – No
12% – Yes
4% – Asking yes, acting is another matter
On the topic of acting, we asked if plan sponsors were acting on implementing ESG was going:
40% – No
34% – Some are, most aren’t
14% – Mostly they seem to be “window shopping”
6% – Many are, but not all
5% – Yes
Request ‘Ed’
Some reader comments on those plan sponsor requests (MORE COMMENTS ARE HERE):
We have some non-profits and firms with a large millennial population that have inquired about it. Only a few added an ESG option, which we screened carefully.
Although it’s becoming a prevalent topic in the investment world, there’s minimal response or inquiries from Plan Sponsors. I don’t believe that people as individuals, have bought in to ESG issues, in general, much less consideration to support (invest in) companies that are attempting to address these issues. Therefore, if they, as individuals, don’t embrace or feel accountability for some of our global “woes,” they won’t make the connection to add ESG focused investments to their retirement plan’s investment options.
We have a number of environmental groups that wish to add the offering and committees that have asked because specific employees have requested. In situations where the organization is built around it, we take our screens a step deeper to run a final analysis on how the funds would screen in an ESG discussion. When it is for a specific investor, we speak to the committee about the decisions needing to be made for the whole and if only one individual is looking for these type of options maybe a brokerage arm, mutual fund window or outside investment will best suit that individual. So a very large “it depends.”
Most participants are focused on expenses, and being in investment options that will help them reach their goals. Plan sponsors seem to leave their faith in the individual companies to be doing the right things. I have noticed more plan sponsors digging into the individual holdings, CEOs, and board members.
I have spoken about ESG investing mostly to endowment and foundation committees—retirement plan committees have less interest.
The requests typically only happen if an employee has asked the sponsor for them. Most if not all sponsors aren’t proactively asking to have them in the plan.
401k plan sponsors are coming to me as I have depth of knowledge in this arena. Their employees are asking for these options.
We have a few nonprofits that actively have asked and actively use socially responsible funds, for a long time. It is part of their internal culture and company governance policies. They also have a wide variety of active and passive investments to choose from. The ESG (previously referred to as socially responsible) is only a small part.
We had one client that inquired about it for the default investment thinking that might appeal to their younger employees and make them more likely to enroll. When I asked if they were ok with using a fund company that incorporates it into its screens and stock selection process but doesn’t make it the ONLY criteria, they were on board. I gave the example that the investment company considers ESG factors as competitive factors in evaluating stocks, so it will include the less-environmentally terrible fracking company, and if all other quantitative factors considered pass, doing the same service with better impact could presumably lead to a competitive advantage. They got it and were happy with that. We definitely had the conversation about the fiduciary responsibility as it relates to using participant funds for other purposes though.
It doesn’t come up very often.
We have many nonprofit firms that are environmental organizations. They have a corporate culture to improve the environment.
We have seen more requests from companies who themselves have been asked about their ESG process/policies by analysts and their investors.
Very few are asking. The tiny minority who have asked have implemented ESG options IN ADDITION TO a standard core menu lineup i.e., they are in addition to [not in place of] other standard offerings.
Few ask for the option. We are careful to make appropriate performance comparisons and other fund management measurements with non-ESG fund in the same asset class. ESG is not an asset class unto itself. If the fund passes all other screens and has some ESG principles then it can be considered.
We turned down an $80 Mil RFP in NYC for a plan that just wanted ESG screened investments.
Most of the hype is sell side, i.e. from the fund industry marketing to gather more assets in a different way as active managers struggle for market share and a new different angle
Some clients that market socially responsible principles, along with clients that have larger millennial populations seem to be come to the table with inquiries about ESG funds for the 401k Plan. I’ve also seen clients in certain regions (i.e., Vermont) be more interested in ESG funds for the 401k Plan.
Definitely more prevalent in the non-profit space. Check out the stats on 401(k) vs 403(b) from PSCA.
Clients involved with ESG-related activities, as well as other sectors where divestiture is concern, have inquired about and often implemented ESG options.
We work with many non-profit plans and plans with very young employees. These are the plans we are really discussing ESG options. For one client, ESG is extremely important for them as it’s the foundation of their company. Do most clients want, no. But it’s that always the case? It’s an option for the ones who feel very strongly about the topic.
Despite the social appeal of these funds, given the current governmental temperament towards ESG funds, most plan sponsors would rather avoid the possibility of audit, penalties, or lawsuits.
Only about 2% of our book offers at least 1 ESG offering by design/definition.
Depending on the size of the plan, most are interested but not overly excited as availability in the past was scarce without a significant cost.
All of my plans have at least 50% ESG options in the plan.
Those interested have had the SRI for a long time.
It depends on the industry, demographics and culture of the company as a whole.
Our firm has developed a fiduciary focused presentation on ESG Fund considerations to guide a discussion with Committees. Once Committees understand all of the variables and considerations, fewer make the decision to add them. Our approach is to recommend access through a Self Directed Window, to provide awareness on the Morningstar ESG factor scoring for funds offered in the plan, to then consider an ESG balanced fund option, and to the extent the Committee has determined the specific focus of ESG funds to offer in the plan—we ensure that all recommendations meet the same scoring / monitoring criteria used for other active / passive funds offered in the plan.
In 403(b), there are often legacy ESG investments that the plan sponsor may not have discretion over.
We discussed with many clients a few years ago but very few added to the plan. We felt it was important to discuss though.
Participant Take-Up
As for participant take-up once an ESG option was added (for the 63% who had plans with an ESG option):
57% – Tepid at best
31% – Modest but enthusiastic
12% – Very positive
“Many participants are on autopilot and when just adding a fund, vs mapping assets to a fund as we are with ESG it will take some time to educate an entire participant base on how and why they work and see participants take action.”
“Very small group of very enthusiastic participants”
“Typically based on the interest of a few vocal employees or the ownership. Exceptions to that are faith based institutions where this topic is a driving force in selection.”
“Those that understand what the fund seeks to do are very positive and enthusiastic. The majority are not aware without education on the option and even then only view it as an offering and make their decision based on past performance, fee and a diverse allocation.”
“This is what they are looking for. Why work at an environmental non-profit, protesting climate change only to turn around and support the companies causing it?”
“Some are incredibly excited. More so the companies that have an ESG purpose based on what they do and those with younger demographics.”
“Some uptake but no overwhelming utilization.”
“Tends to attract less than 2% of assets.”
“It’s a minority of participants who we will hear from or who will engage with ESG as a screen.”
“The participants that want them are very enthusiastic.”
“The people who like it seem to really like it…”
“Most participants are more concerned about performance and/or don’t understand the difference. But the ones who raised the subject in the first place are totally on board. So it’s a mixed bag and definitely requires education.”
“It’s like anything—the majority of participants follow default recommendations (i.e., QDIA, do it for me). Our firm would not recommend an ESG fund / target date funds as the plan’s QDIA. More education / awareness would be needed to drive adoption. Many providers are hesitant to do “plan specific ESG fund menu” education or awareness due to compliance concerns.”
ESG QDIA Qualified?
Speaking of ESG as a QDIA, that was another aspect of the Labor Department’s proposed rule. In fact, the proposed rule singled out ESG as a QDIA, noting that it “does not believe that investment funds whose objectives include non-pecuniary goals—even if selected by fiduciaries only on the basis of objective risk-return criteria consistent with paragraph (c)(3)—should be the default investment option in an ERISA plan.” Asked their opinion of that perspective:
32% – The same criteria should apply to all default option considerations
25% – Irrelevant since I would never choose ESG option as a default
18% – Makes sense to me
8% – Haven’t given it much thought
5% – They’re WAY off base
The rest were in an “other” category, including comments like these:
If an ESG passes all the other scrutiny of a QDIA, simply being an ESG offering should not disqualify it from being a QDIA option. If it doesn’t pass the fiduciary ‘smell test’ that’s a different story…
I agree that the QDIA offering should be in the best interest of the whole. Since this is such a large cross section of employee, it is our belief that a managed offering, ideally in an age based approach, would have the highest level of success in capturing a higher sampling. ESG, in our minds, would be an additional/specialty option that individuals can get access to if they desire, and they can compare it against like offerings in the menu for a final decision.
I think it depends on the company, the employees, and their investment profiles. We’re a long way off on offering ESGs as QDIAs, but could see it in the future as more pressure is placed on ESG screenings by incoming generations
I believe the phrase is generalizing; however, there is validity to the suggestion. How will an underutilized, underperforming (at times) ESG Fund that lacks historical value compete in the DOL TIPS process with a top performing target date series as a QDIA? Target Date Funds were designed with specific criteria to match the goals and objectives for participants in the accumulation phase as well as the income phase. Therefore, while I believe the phrase is generalizing in nature, I believe the intent of the suggestion is that the risk/return of ESG strategies are different and not built for retirement outcomes but rather social/humanitarian awareness.
QDIA of one fund… which for ESG is typically only one assets class… would not serve as a prudent QDIA since it wouldn’t be a diversified portfolio and or asset allocation.
Not sure why you would differentiate. A fund that is a designated investment alternative or a QDIA should both have the same overarching standards applied to them.
We have not used an ESG fund as a QDIA. Although, as they get more traction and performance data, I could see this changing.
As mentioned previously, the DOL ERISA fiduciary obligations require all plan fiduciaries put the best interest of the plan participants above all other considerations. Taken literally, and the courts tend to take things literally, ESG considerations cannot be placed above other considerations. This would suggest the funds in the plan must be able to stand head and shoulders above other fund options prior to the application of an ESG filter.
This one is puzzling—if it’s good enough for the main menu why not as a QDIA?
Other Comments
Yes, we did get a lot of comments this week. Here’s some more:
There is nothing wrong with offering an ESG fund as an option; some participants may wish to use their retirement plan money to fight to prevent global warming, environmental disaster, and the obscene proliferation of guns. It’s all about government officials getting political contributions from companies that might get additional investments if ESG funds are discouraged in retirement plans.
It’s more of a wait and see for my clients.
Out of touch with reality (and prior performance)
ESG is a topic our plan sponsors have appreciated us educating them about. In our IPS, ESG funds must meet the same IPS criteria as all the other funds and it is a proven winning investment strategy.
ESG shouldn’t be an option, it should be the standard. Why is there no corporate mandate to just be ethically and socially responsible in general? This is the future of society and our planet we are talking about.
I am seeing growing enthusiasm for the concept of ESG especially among my fellow millennials. I believe it is here to stay despite the recent DOL proposal.
The investing public is placing a focus on ESG issues… this guidance smells like it has a political bias. I don’t think ESG should be the driving force in selecting an investment menu, but I don’t think it can be ignored as a factor moving forward.
ESG is most certainly important, but it is not the end all be all. Again Morningstar has their own sustainability ratings that include these metrics for all funds, and it is a set of data that needs to be considered with all of the other data.
I’m surprised the DOL believed they had to issue a rule on ESG investing- almost a reaction out of fear rather than because it’s been widely adopted. It boils down to the selection process—same as when SRIs were the buzz. And just because a few employees ask for it doesn’t mean it’s best for all.
Specialized fund that should be treated like any other specialized fund—not recommended on a retirement plan.
Performance needs to warrant it being in the menu.
I think participants should have the option to invest in ESG funds in a plan… it’s just finding “pure” ESG funds that are suitable and fit generally within a plan’s IPS (with minimal exception).
Plan sponsors and employees want ESG. Living your values AND making money are not exclusive. Stranded asset risk is real and it impacts performance.
The only time I hear about ESG is at an ARA type function. It never comes up with clients unless I bring it up and I usually don’t. We look at all investments and if it’s a good fit for our client, we recommend it whether it’s ESG or not. Since we haven’t been recommending them, it appears that they haven’t been doing good enough to hit our radar.
Conceptually, agree with ESG investing. however, have not been convinced it is in the best interests of the plan participants
This is a marketing pitch by fund companies to sell active management, no thanks.
I generally only suggest a large cap blend ESG index option or self directed brokerage to clients. Most opt to add the large cap blend ESG option.
I am a proponent of ESG and hope to see more companies and fund managers striving to balance sound investment with sound business practices. We should be rewarding and supporting these types of companies!
As long as the committee follows and documents a prudent process, whether or not they want to look at ESG factors as part of that process, it should not be controlled by the DOL. That means looking at risk metrics, returns and expenses over periods of time.
We have seen very few queries for ESG. Those we have received have actually been more focused on funds that are compliant with Sharia Law. We have amended language in only a couple of IPS to reflect the desire to SUPPLEMENT the standard core menu with ESG and/or Sharia-compliant funds.
With very few exceptions, plan participants are not asking for ESG options. As a result, plan sponsors are not asking about it. With all the other difficult business decisions having to be made in 2020 this is probably at the bottom of the list of things to address or take under consideration.
To me this DOL action is more a clarification and reminder of ERISA prudence than something that changes it. Not sure they needed to speak up with regulation vs. with a bulletin. I believe that there is a growing ability and effort to demonstrate that ESG factors can in fact lead to better outcomes when analyzing risks/rewards. Demonstrating the benefits of ESG is a case the that ESG proponents need to make in order to create “cover” for those wanting to justify ESG investment. And then, just like always, it will boil down to: Did you as a plan fiduciary have a process? Did you weigh the pros/cons? Can you point to /document your consideration as a fiduciary of all the facts and circumstances and alternatives to justify your decision? If “yes,” and your process is reasonable, then you should be able to come to a defendable conclusion of why you selected ESG.
Our firm has developed a fiduciary focused presentation on ESG Fund considerations to guide a discussion with Committees. Once Committees understand all of the variables and considerations, fewer make the decision to add them. Our approach is to recommend access through a Self Directed Window, to provide awareness on the “Morningstar ESG factor scoring” for funds offered in the plan, to then consider an ESG balanced fund option, and to the extent the Committee has determined the specific focus of ESG funds to offer in the plan — we ensure that all recommendations meet the same scoring / monitoring criteria used for other active / passive funds offered in the plan. Some clients that market socially responsible principles, along with clients that have larger millennial populations seem to be come to the table with inquiries about ESG funds for the 401k Plan. I’ve also seen clients in certain regions (ie. Vermont) be more interested in ESG funds for the 401k Plan.
For some of our clients offering an ESG option in the fund line up addresses the socially responsible values of their institution. Even in these cases, only seeing minimal participation by participants. We have studied the performance of countless ESG products and they do not outperform.
Just make up your mind (from a regulatory sense) so we can all get on with it!
As a plan sponsor, we feel participants may invest in funds or securities that fit this mold, through a brokerage-window.
Why is the DOL going to the extreme to discourage the use of ESG funds? If they do with these funds, who is to say they won’t discourage other types of funds? Private equity is okay but ESG isn’t? What is happening? Plan sponsors are supposed to evaluate investment objectives. Why can’t they include ESG as an objective? Something doesn’t smell right and there is a hidden agenda somewhere. Okay, I’m done ranting.
In researching some of the investment options we are already using, irrespective of their ESG-ness, many already have high ratings on the ESG scale. I think more companies are paying attention to this and perhaps, one day, whether or not a fund specifically sets out be ESG might become irrelevant.
DOL is spot on!
Man, the DOL has certainly been productive during this pandemic!
Thanks to everyone who participated in this week’s NAPA-Net Reader Poll! Got something to say? Poll is still open at https://www.research.net/r/8WL6CRD.
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