While institutional investors have shown continued interest in environmental, social and governance factors, DC plans apparently still have a ways to go.
Overall incorporation of ESG factors into the investment decisionmaking process nearly doubled to 42% in 2019 compared to 22% in 2013, according to Callan’s 2019 ESG Survey. Moreover, the ratio of investors either incorporating or thinking about incorporating ESG was about half of the respondent pool in 2019. That said, the survey also revealed an ongoing disparity in adoption rates by investor type and size.
The survey was conducted from May to July 2019, and reflects input from 89 U.S. institutional investors who were asked about their approach to ESG factors when evaluating investments. For this survey, Callan notes that ESG factors include socially responsible investing (SRI, including divestment), sustainable investing, responsible investing, impact investing and other associated terms.
According to the findings, DB and DC plans – both public and corporate combined – incorporated ESG at a rate of 35% and 36%, respectively. The authors note that this represents a shift for DC plans, which previously had much lower ESG utilization rates than DB plans, but there are some noteworthy caveats, including a relatively small sample size.
Not surprisingly, public plans have incorporated ESG factors into the investment decisionmaking process at a higher rate than their corporate counterparts. When looking at just the corporate side for DB and DC plans, the rate drops to 19% in 2019, but this is up from 14% in 2013.
For additional context, the study shows that 18% of plans in Callan’s DC Index offered a thematic ESG fund option, where the fund name conveys the ESG approach, up slightly from 16% in 2018. “This is a common implementation approach for defined contribution plans; adding a standalone ESG option can be a direct way of offering plan participants a sustainable investment choice, for example,” the authors note.
And while thematic ESG funds are increasing, so too is the number of funds using ESG integration (i.e., employing ESG data and considerations in the investment analysis process) — which appears to be a far more prevalent approach. According to Callan’s data, fewer than 1% of the 2,400-plus fund options in the firm’s DC Index were thematic ESG options, but 20% of the funds indicated they integrate ESG into the investment process. And while only 18% of plans have added an ESG-themed fund to the lineup, the vast majority of plans (94%) had exposure to ESG-managed assets, where at least one fund manager indicated they use ESG considerations in the investment process.
Considerations
The most frequently cited reason for incorporating ESG among respondents was to align the portfolio with the organization’s values. Conversely, the most frequently cited reason for not incorporating ESG among respondents was the fund’s decision not to consider any factors that are not purely financial — this was according to 53% of such investors.
Other top reasons for not implementing ESG include:
- lack of research typing ESG to outperformance (33%);
- unclear value proposition (31%); and
- don’t know whether ESG factors would fit in the fund’s strategic asset allocation (12%).
The study notes that emerging research supports the notion that ESG issues can have material financial impacts in certain investment situations. For example, it notes that the CFA Institute “sees value in the incorporation of ESG data into the investment process, but it is agnostic on the value-investing argument more pertinent in the SRI community.”
Looking Forward
Callan’s study also found that 12% of respondents that have not yet incorporated ESG into investment decisions are considering doing so in the future. The authors note that this figure has fluctuated from 10-20% over time, suggesting that more investors will explore and implement ESG in the future.
By type, 22% of foundations, 16% of public plans and 6% of corporate plans which have not incorporated ESG into investment decisions are considering doing so. None of the endowments surveyed which are not incorporating ESG are considering doing so, but endowments also have the highest ESG incorporation rates (58%) in 2019’s survey. And nearly half of respondents that have incorporated ESG factors in investment decisionmaking will seek better quality, more detailed or different ESG data in the coming years.
In addition, more than a third (35%) will broaden the scope of ESG incorporation. Specifically, respondents indicated they will look to incorporate ESG by:
- adding real assets and fixed income;
- seeking managers with better ESG processes and outcomes;
- using new or different reporting frameworks;
- including more impact investing;
- enhancing engagement and monitoring; and
- developing policies (e.g., investment beliefs, proxy voting).
