Cerulli Finds All Talk, No Action Regarding DC Plan ESG Investment Adoption

Cerulli Associates found fee sensitivity and the notion that environmental, social and governance (ESG) investing entails a trade-off in performance are two broadly applicable headwinds to ESG adoption.

The topic of environmental, social, and governance (ESG) investing has permeated the asset management industry in recent years, spanning distribution channels and client types. But while Cerulli Associates says it would not describe the defined contribution (DC) retirement plan market as a hotbed of ESG activity, an uptick in ESG-focused conversations is noticeable.

According to the Cerulli Edge, U.S. Retirement Edition for 1Q 2019, more than half (56%) of the 1,000 active 401(k) plan participants it surveyed agree with the statement, “I prefer to invest in companies that are environmentally and socially responsible.” However, when Cerulli asked plan sponsors to identify their top-three most important attributes considered when selecting 401(k) plan investments, “environmental and social responsibility” ranked last with 16% of responses.

Cerulli found fee sensitivity and the notion that ESG investing entails a trade-off in performance are two broadly applicable headwinds to ESG adoption. Another challenge specific to the DC market is the regulatory environment.

Long-term investment performance and cost of investments were the top-ranked attributes considered when selecting 401(k) plan investments, gathering 45% and 38% of responses, respectively. “Data shows that plan sponsors care about ESG factors, but they place a greater emphasis on performance and price,” the Cerulli reports says.

Cerulli cites Callan research that shows ESG investment adoption in DC plans is low, and says, given that Callan’s clients comprise mostly large and mega plans, “which are typically forerunners in market trends,” ESG adoption in the overall DC market may be even lower.

Cerulli also notes that guidance from the Department of Labor (DOL) has caused confusion and perhaps stymied the adoption of ESG investments in DC plans. In 2015 and 2016, the DOL issued field assistance bulletins related to the evaluation of ESG factors in ERISA-covered retirement plans. Within this guidance, the DOL stated that fiduciaries may use ESG factors as a “tie-breaker” when choosing between two investment options that are otherwise equal with respect to return and risk. This guidance was largely viewed as supportive of increased ESG adoption in the DC market.

In 2018, the DOL issued further ESG-related guidance intended to clarify prior years’ bulletins. The 2018 guidance takes a contrasting tone and explicitly scrutinizes the use of ESG-themed investments as a plan’s qualified default investment alternative (QDIA).

Cerulli says this guidance raises an important point related to ESG investing in a DC plan context: ESG investments must be prudent options for all plan participants, not a select group or sub-segment. “Cerulli contends the best path for ESG-oriented funds to gather assets in the DC market is in a QDIA role, but the DOL guidance and idiosyncratic nature of ESG investing create significant hurdles,” the report says.

Cerulli adds that several asset managers note the challenge of effectively benchmarking ESG funds, and suggests that if asset managers grapple with the complexities of ESG benchmarking, one can assume that less sophisticated stakeholders (i.e., end investors, plan sponsors, and, to an extent, advisers) have less knowledge in this area. “This example underscores the importance of educational efforts in spurring greater ESG adoption in not only the DC market, but also the entire asset management industry,” Cerulli suggests.

More information about this topic can be found in The Cerulli Edge―U.S. Retirement Edition, 1Q 2019 issue, which may be ordered from here.