Even with the various barriers to adoption, most DCIO asset managers expect to increase their DC-focused ESG marketing and distribution efforts during the next 12 months, according to a new report from Cerulli.
In U.S. Defined Contribution Distribution 2020: Adapting to Changes in the Regulatory Environment, the firm reports that nearly half (48%) of DCIO asset managers it surveyed consider the Department of Labor’s proposed regulation on environmental, social and governance (ESG) investing as one of the most significant barriers to adoption of ESG products in DC plans.
And while industry stakeholders suggest the DOL’s proposal will create undue barriers, the proposed regulation apparently is not slowing down marketing and distribution efforts promoting DC-focused ESG products. According to Cerulli’s research, 56% of DCIO asset managers expect to increase these efforts during the next 12 months.
“For now, implementing ESG-themed products within a plan’s QDIA is not a viable option from a fiduciary standpoint. However, DC asset managers relate that some of their plan sponsor clients continue to express interest in ESG investments,” notes Shawn O’Brien, senior analyst at Cerulli.
The DOL proposed new regulations in June to codify the department’s longstanding position that ERISA requires plan fiduciaries to select investments and investment courses of action based on financial considerations relevant to the risk-adjusted economic value of a particular investment. The proposal also requires ERISA fiduciaries to complete more stringent evaluations of ESG investments, including new investment analysis and documentation requirements and prohibits the use of ESG-themed funds as a plan’s qualified default investment alternative (QDIA) or a component of a plan’s QDIA.
Yet, according to Cerulli’s findings, many asset managers tout performance-related benefits to incorporating ESG criteria into their investment analysis, even within non-ESG-branded funds. “Many asset managers stand behind the financial merits of ESG. Some asset managers tell us they employ ESG screening processes or incorporate ESG factors into their investment analysis across all of their funds,” observes O’Brien.
Moreover, three-quarters (75%) of asset managers cite mitigating risk as a top reason for incorporating ESG criteria into their investment analysis and more than two-thirds (68%) indicate incorporating ESG criteria leads to improved alpha opportunities.
Lingering Confusion
Along with the “regulatory headwinds,” retirement plan providers suggest confusion related to ESG investing has also contributed to a lack of adoption by DC plans. In the absence of universally accepted definitions and terminology, providers should consider taking a step back to address the fundamentals of ESG investing in order to facilitate more nuanced discussions with their DC clients, the report notes.
“There seems to be a lingering confusion among plan sponsors and participants about how ESG investing works. Managers should seek to educate DC plan sponsors and intermediaries on the various methods of ESG investing and illustrate how their firm’s product fits within the broader ESG landscape,” O’Brien suggests.
“Moreover, helping plan sponsors articulate and document investment decisions related to ESG products—and ensuring those decisions are consistent with the plan’s IPS—will be particularly important given the current regulatory environment and the litigious nature of the DC market,” he further emphasizes.
As to educating DC plan sponsors and intermediaries on the various methods of ESG investing, this was a topic that came up last month at the 2020 NAPA 401(k) Cyber Summit. NAPA will be partnering with LeafHouse, ZUNA and other firms to roll out an ESG certification program to educate plan advisors about ESG investing.
Regarding the DOL’s regulatory efforts, it’s worth reiterating that the proposal has not yet been finalized and, in fact, received numerous comment letters that were critical of the proposal, including concern by the American Retirement Association. It’s also possible that a Biden administration would seek to overturn any newly finalized rule by the DOL.
