Ed Farrington, Executive Vice President, Institutional and Retirement, for Natixis Investment Managers, discusses ESG investing, at the virtual 2020 PLANSPONSOR National Conference.
PLANSPONSOR: Can you describe what the acronym ESG [environmental, social, governance] means for the retirement-plan sponsor community? Would you explain how modern ESG products work?
ED FARRINGTON: For about five years now, we’ve been advocating for the expansion of ESG strategies inside defined contribution plans—including, three-and-a-half years ago, launching a target-date range where all of the underlying strategies integrate ESG into the investment process.
Whether or not to take such steps is now a commonplace conversation, driven by both demand and a growing body of evidence that ESG criteria can help investors become better investors. About 90% of the companies in the S&P 500 now produce some form of corporate responsibility reports, where they issue data on how they behave in terms of environmental, social, and governance policies.
And as an investor, if you have access to that data, you’ll start to see if there is a way you can draw an inference between that data, those behaviors, and the performance of the company. And lo and behold, we are finding, from a risk management standpoint, that companies that manage environmental, social, and governance risks perform well over time.
Our belief is that managers that know how to integrate this information will have an information advantage over those who don’t integrate it. And you are seeing that now in ESG-themed funds, funds that are saying that they are sustainable, responsible. But you’re also seeing it from traditional managers who are incorporating ESG data into their traditional investment process and many times to the economic benefit of their shareholders, who include, plan sponsors, investment committees, and ultimately, participants.
PS: What is the demand for this in the marketplace?
FARRINGTON: We know there is increasing demand, from a participant level, for these types of strategies. Certainly, there’s broad demand for more options in this space, but specifically from the Millennial generation.
By the year 2025, 75% of the workforce will be Millennial. That means 75% of our participants. And in fact, they’re a growing economic force as they enter their 40s and begin to have increasing influence over the workforce and, therefore, over the benefits world.
And we also know from our DC plan participant survey that six in ten participants say they would like to see more socially responsible investments in their plan offering. Additionally, seven in 10 Millennials state that they’d invest in their plan for the first time or increase their contribution rate if they had access to responsible, sustainable, or ESG investments. We think these two roads can merge and do so in a way that meets this demand, while also meeting the fiduciary duty that is on the shoulders of plan sponsors.
PS: How should plan fiduciaries think about these investments?
FARRINGTON: For any defined contribution plan, it’s important to begin with knowing there are two paths. One attracts investors who are trying to make a better world. The second attracts investors who are just trying to become better investors. When it comes to the sponsor of a DC plan, it’s important to start down the road of better investing—what I consider the economic benefit—not the road of better world investing—what I would refer to as the collateral benefit.
Investors might wind up influencing, and improving, the world. But it’s key to start with creating better economic outcomes for participants, because they’re already engaged in a social benefit in a defined contribution plan.
When it comes to the role of a plan sponsor serving the economic needs of a plan participant, it is critical the sponsor remain focused on ESG factors that contribute to the economic performance of the underlying strategy or holding. If ESG investing is about creating economic value, that is in line with the duties of a plan sponsor or an investment committee member.
PS: Can ESG can be a normal part of a fund that’s seeking the best returns possible, or is it an add-on?
FARRINGTON: There’s growing evidence that ESG factors can help investors, plan sponsors, investment committees, et cetera, identify and manage risks that will show up in the security price of their participants’ holdings over the next 10, 20, 30, 40 years.
If you looked at the underlying components of our target-date range, we have both intentional ESG investors and ESG integration managers who you wouldn’t say are intentional ESG managers. But we mix the two together because of this focus on economic outcome.
The duty of the sponsor is to not constrain yourself to only ESG managers in the search. Find out what the process is behind every manager, and you might find there are some that don’t confine themselves to ESG but index quite high when it comes to using ESG criteria. Some of them—particularly the high-conviction active ones—will actually create alpha, as well. You might be able to satisfy that inclusion in the plan menu without having to call it sustainable, responsible ESG. You might just find [ESG]’s a really important part of the investment process of something you already know, like and trust.
PS: Is there a difference in ESG depending on the type of fund, such as equities versus fixed income?
FARRINGTON: For Natixis, in deciding to have a target-date range that integrates ESG, you obviously have to have both equity and fixed income. To me, ultimately, the way to think about this is risk management. That shows up whether the issuer is on the equity side or the debt side.
We’re all seeing increasing evidence, from a credit-rating standpoint, that these are material issues. You can find guidance through places like SASB [Sustainability Accounting Standards Board], which will help you map what factors are material for different industries and, therefore, for different issuers underneath those industries when it comes to their financial performance. So there’s absolutely a way to integrate ESG criteria into your fixed-income portfolios.
I’m not trying to mention only our own affiliates. I’m only mentioning them because that’s the experience I live, day to day. Loomis Sayles, which is one of the larger fixed-income shops on the planet, and certainly has a strong history and credit analysis—integrates ESG in its processes. It manages ESG-specific portfolios. But if you ask people there, they’ll say they’re integrating that data in all of their portfolios. They have pointed ahead of ESG for the firm several years ago. It’s just part of the firm’s DNA when it comes to credit analysis.
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