Defined contribution retirement plan sponsors have a journey ahead when weighing whether to add environmental, social and governance funds to investment menus.
Challenges for plan sponsors with participants showing greater interest in sustainable investment and ESG funds are myriad, according to industry experts. Plan sponsors must determine the plan’s ESG philosophy and goals for sustainable investing and communicate these to plan participants. But plan sponsors’ communication to and education of participants must account for fiduciary obligations, and not constitute investment advice under the Employee Retirement Income Security Act.
Retirement plan fiduciaries who are considering adding ESG funds to their investment lineups would be wise to map their traditional investment selection process to sustainable investments, says David O’Meara, director of investments at Willis Towers Watson. Each sustainable investment selection must be inspected under a fiduciary lens.
“We see it as looking across all funds—whether or not it’s a branded ESG [fund]. ESG evaluation as part of the overall investment process should be accounted for by plan fiduciaries as they’re evaluating their investments. Whether or not a fund is branded ESG or not, the evaluation needs to be similar and [ESG funds] effectively need to be looked at as a valuable component to a participants’ portfolio,” he says.
Examining and adding ESG is a challenge for DC plans because participants may not understand the terms and the underlying process, nor how the funds invest. The challenges for plan sponsors are educating retirement plan participants on ESG funds, communicating appropriate allocations to ESG funds and explaining terms and how sustainable funds invest, says O’Meara.
“There isn’t a lot of communication going out that’s necessarily differentiated for ESG versus non-ESG,” he explains.
Plan sponsors are concerned that communication “could be viewed as advice, and any investment advice is a different level of fiduciary standing, so the plan fiduciaries tend not to want to be viewed as providing investment advice on specific investments to participants.”
When an ESG fund is added, O’Meara says, plan sponsors’ communication to participants is often not distinct, as plan sponsors tend to limit any communication campaign to simply notifying participants of a new fund option. “There likely can be enhancements to reiterating to plan participants what all of the options are, and why those options are being made available to their participants,” he says.
But many plan sponsors want to do more than provide an ESG option on the fund menu, and are evaluating not just how to add an option but how to educate participants without overstepping fiduciary bounds by providing advice.
“It’s always a challenging line to educate without advising—when you start talking about specific investments—and as the industry evolves, there’s going to be better communication techniques that are developed,” O’Meara says. “They’re not well-developed at this stage.”
He advises plan sponsors to tread carefully, and—when possible—to tap resources from the plan’s recordkeeper, retirement plan adviser and investment management partners. Recordkeepers, for example, can advise participants directly.
“Advice programs that are that are available in DC plan[s] today tend not to incorporate or distinguish ESG as a component of their evaluation and tend to be incomplete in that way as far as helping participants to incorporate ESG, because it’s not really part of their algorithm for evaluating funds,” says O’Meara.
For example, he says, plan sponsors are currently integrating sustainable options as standalone funds rather that utilizing whole suites of ESG-focused target-date funds.
The first step Willis Towers Watson takes when adding sustainable investment options to a plan is to facilitate the plan sponsor as a fiduciary to evaluate the ESG factors in every plan investment, whether labelled ESG or not. This “facilitate[s] the process to then communicate that out to participants that ESG is one of the components that the plan fiduciaries evaluate in determining which funds be made available to participants,” O’Meara says.
The Defined Contribution Institutional Investment Association has published a framework to help plan sponsors, “ESG and Participant Communications: Practical ideas for how to communicate the integration of sustainable investing within DC plans.”
DCIIA advises that adding sustainable investments to a defined contribution plan and communicating to participants is a final step in a four-act journey where plan sponsors must establish ESG beliefs and plan policy, process and the fund lineup. DCIIA previously counseled plan sponsors in a 2021 framework to define terms such as sustainability.
Robert Appling, managing director at Wilshire, agrees that establishing a process is crucial.
“The most important factor is really defining what your goals and objectives are, as it relates to ESG,” he says. “That is the goal for plan sponsors. Then have that memorialized into your investment policy statement. That’s really critical.”
After the plan sponsor has done that, it’s important to assess the rest of the employer’s operations, including any of its own investment holdings and ESG risk exposure, he adds.
“The third step is then to be aware of where your current ESG risks are, to start tracking that,” Appling says. “Starting the race, know where you are, so that you can monitor [it] and show progress over time.”
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