PSNC 2020: Time to Get Serious About ESG?

Environmental, social and governance investing is slowing becoming pervasive in DC plans, particularly as Millennials are poised to become the majority of the workforce.

The important thing for retirement plan sponsors to consider when deciding whether to include environmental, social and governance (ESG) funds in their plans’ investment lineups is if it will improve their participants’ performance—not whether it is making a difference in the world, said Ed Farrington, executive vice president, institutional and retirement, Natixis Investment Managers—U.S. Distribution, at the virtual 2020 PLANSONSOR National Conference.

“There is growing evidence that ESG can help plan sponsors and advisers identify and manage risks,” Farrington said. “Demand will increasingly grow. By 2025, 75% of the workforce will be Millennials, and, as such, they will wield influence over the workforce, and, therefore, the benefits world. The important thing for plan sponsors is to meet this demand while also meeting their fiduciary duties.”

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Cammack Retirement’s client base includes many universities and public sector plans, including a leading organization in wildlife conservation, and “these clients have taken a keen interest in ESG investing,” said Michael Volo, senior partner at the advisory practice. “There has been a lot of growing momentum in the past 12 months.”

“Investor interest is running years ahead of regulation, if not decades,” said Hernando Cortina, head of index strategy, at ISS* ESG. “There has been massive growth in ESG investing in the past 12 months. ESG now comprises 10% of ETF [exchange-traded fund] assets, totaling $6.2 billion. Net flows into ESG ETFs are 10% of the market, which is quite meaningful.”

Farrington noted that the Department of Labor (DOL) first issued guidance on ESG investing in 2008, under the George W. Bush administration. “Every presidential administration since has had some opinion on incorporating ESG into a retirement plan menu,” he said. “It is critical that plan sponsors understand that and ensure they are meeting their fiduciary duty while also innovating by including ESG to offer a better investment process.”

There are several ways plan sponsors can include ESG strategies in their investment lineups, Farrington said. They can find standalone ESG funds, he said. However, it is more common for them to find target-date funds (TDFs), balanced funds or managed accounts that include ESG principles in their investments, he said. What sponsors may not realize, Farrington said, is that “90% of the companies in the S&P 500 issue data on how they behave in terms of ESG policies. For the past decade, research analysts have had access to data to see how ESG impacts performance.” Many funds that do not explicitly say that they are ESG focused actually incorporate these principles, so sponsors can ask their retirement plan advisers to find out what the ESG exposure in their investment lineup is, he suggested.

As to how ESG affects performance, “there are plenty of studies that emphasize that integrating ESG into the fund selection process can lead to similar, if not better, returns,” Farrington said. “Managers who can integrate this will have an information advantage.”

Again, however, Farrington said it is critical that when considering ESG investments, sponsors look to ensure that they are adding to the “economic benefit of the participant, not the collateral benefit. This is really critical when it comes to the role of a plan sponsor serving the needs of a plan participant.”

The DOL’s proposed rule on ESG investments, which it issued this summer, emphasized that including such investments in a retirement plan lineup “has to be for the economic benefit of the plan,” Volo said. “Most read the proposal as pushing back against ESG, but, at the end of the day, the DOL was reiterating that fiduciaries have to do what is in the best interests of participants and that ESG investment returns have to be at least on par with non-ESG investments.”

Of the 1,500 comments the DOL received in the condensed, 30-day comment period it gave the public, most of the remarks were negative, asking the DOL to alter its guidance, Volo noted.

“DOL’s proposed rule may slow down ESG momentarily, but not in the long term,” Volo said. “There is a lot of momentum and data behind ESG investments. I believe we are reaching an inflection point,” he said. “But I still think we are in the early innings for ESG in retirement plans.”

*Editor’s note: PLANSPONSOR Magazine is owned by Institutional Shareholder Services (ISS).