Self-Directed Retirement Plan Participants Allocate Few Assets to In-Plan ESG Funds

Among do-it-yourself investors, allocation to ESG funds is ‘relatively modest when offered in the core menu,’ shows research paper from PGIM and EBRI.

Self-directed retirement plan investors infrequently allocate to environmental, social and governance investments, new research finds.

The research, by PGIM and the Employee Benefit Research Institute, examined the allocation decisions of 9,324 new defined contribution plan participants, across 108 DC plans, who are directing their own accounts and where there is at least one ESG fund available in the core menu.

Although some clear demographic preferences for ESG funds emerged in the research – for example among younger participants with higher incomes – ESG allocations were found to be primarily a function of weak preferences, wrote the authors, David Blanchett, head of retirement research at PGIM DC Solutions and Zhikun Liu, senior research associate at EBRI.

The average allocation to ESG funds among the participants in the analysis was 1.7% of the total assets and or balances for invested participants, the research shows.  

“I think what the results reveal to plan sponsors is simply that demand for ESG funds in defined contribution [plans] may not be as high as suggested by some surveys,” Blanchett explains in an email. “It’s not that some participants don’t want ESG funds, it’s that there doesn’t appear to be an especially high demand today (i.e., not that much more than other investments available on the core menu).”

Among do-it-yourself retirement investors, 8.9% of participants had any allocation to an ESG fund and the average allocations to ESG strategies among those holding any ESG funds is 18.7% of their total balance, the research shows.

For the analysis, approximately 100,000 participants who are self-directing their accounts – do-it-yourself investors – were culled based on several criteria, including age and years of retirement plan participation.

Blanchett explained retirement plan participants who do allocate to ESG funds are likely driven to invest by naïve diversification rather than the strong conviction to allocate. The self-directed plan participants could be randomly picking funds to build a diversified portfolio, Blanchett said.

“For example, if there are 10 funds available, and I allocate 10% to each one, I’d be diversifying my portfolio by holding multiple funds, but I wouldn’t necessarily have the most diversified portfolio depending on the similarity of the funds I’m selecting,” Blanchett explained.

“No plan offered more than five ESG funds, and the vast majority – approximately 76% – offered only one ESG fund,” the paper states. “This suggests it would be relatively difficult to build a diversified portfolio using only the ESG funds in DC plans currently.”

Among all 108 plans studied, the largest number, 82 or 75.9% of all the plans studied, offered one ESG fund; 17 plans, or 15.74%, offered two ESG funds; five plans, or 4.63% of plans, offered three ESG funds; and three plans, 2.78% of the total, offered four ESG funds.

The researchers concluded that the paper “paints a mixed picture about the actual participant interest, and drivers of demand for ESG funds in DC plans and suggests that plan sponsors should take a thoughtful approach when considering adding ESG funds to an existing core menu.”

The research methodology limited participant respondents to new defined contrition plan enrollees, according to the paper.

The research was narrowed “to ensure we are capturing participant elections to the respective funds,” said Blanchett. “Focusing on new ensures they – likely – had access to the ESG fund when allocating to the core menu and they selected that particular fund.” 

If the researchers instead included all participants, it’s possible the ESG funds may not have been available when the participant decided to self-direct their retirement plan investments, and possible that the funds were “mapped” into another investment the participant originally selected that was replaced with a fund change, he added.

New accounts selected for the research are likely to have lower dollar amounts as compared to older accounts, which Blanchett acknowledged.  

“Newer accounts are [almost] always always the smaller balances unless there is a rollover,” Blanchett said. “This effect is going to persist regardless of participant age. Younger individuals are more likely to change jobs [i.e., have shorter tenure] so they are going to be a higher portion of a group if we’re just focusing on new participants.”

Blanchett added that the study didn’t focus on young retirement plan participants, but instead individuals who had newly enrolled in the plan, who were more likely to be young.

“What this research doesn’t really tell us anything about is things like retirement preparedness or savings,” he added. “For example, some research has suggested participants are willing to save more when they have access to ESG funds.”

Data for the analysis was obtained from a top 10, by assets, recordkeeper of U.S. defined contribution plans, which a PGIM spokesperson did not name for privacy reasons. For the analysis, approximately 100,000 participants who are self-directing their accounts with less than one year of service were initially randomly selected across the entire available participant population. To be included in the dataset, the participant had to meet the following criteria:

  • Participants’ ages are between the ages of 20 and 80.
  • Years of plan participation (i.e., plan tenure) is two years or less.
  • The participant must be coded as actively participating in the plan.
  • The participant must have an income higher than $10,000.
  • The participant must have a balance greater than $1

Data was gathered by EBRI and PGIM, as an extract, in November 2021.

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