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Environmental Impasse?

Industry Trends and Research

A new report claims that participants and plan sponsors are keen on ESG – but apparently not enough to do much about it.

The report, by Cerulli Associates, cites a 2018 survey of 1,000 active 401(k) plan participants among which “more than half” agreed with the statement, “I prefer to invest in companies that are environmentally and socially responsible.” And while that’s just over half (56%), younger participants (under age 40) – and women were noticeably more supportive of the statement.

As for defined contribution plan adoption, Cerulli cites data from Callan indicating that only 16% of DC plans offer a dedicated ESG option, and even among those who do, less than 2% of the plan assets are invested there. Of course, Callan’s data skews toward mega and larger plans, as Cerulli acknowledges. Indeed, according to the 61st Annual Survey of Profit-Sharing and 401(k) Plans by the Plan Sponsor Council of America, just 4% of plans offer an ESG option, and those programs only have 0.03% of assets in those options, with an average asset allocation of just 0.1%.

Connect ‘Shun’?

So, what’s behind this apparent disconnect? Well, in its report Cerulli cites a 2018 survey of 800 401(k) plan sponsors where about half (46%) described ESG factors as a “very important” consideration when selecting 401(k) plan investments. But if it’s very important, it nonetheless comes in well down the list of actual selection criteria; dead last, in fact, among a list of 16 criteria from which plan sponsors were asked to pick the three most important.

In fairness, the items that topped that list were, to my eyes, legitimate criteria for consideration. Long-term performance topped the list, followed by cost and investment style (e.g., active versus passive, which, arguably involves elements of the first two criteria). Tied for fourth? Advisor/consultant recommendation (with recordkeeper affiliation).    

Could advisors be to blame? A previous Cerulli report on the subject suggests that a significant factor in the slow uptick in adoption of ESG are, in fact, advisors – and that the factors holding them back is a perception that these strategies do not fit into client investment policy statements (26%), negative impact on investment performance (24%) and cost (19%).

Indeed, in the inaugural NAPA Summit Insider survey of more than 500 retirement plan advisors, 16% of that group was inclined to label ESG as “over-hyped” – though just as many (20%) indicated it was a topic on which they would like to have more information (for a list of questions, see this NAPA-Net Reader poll from January).

Labor ‘Deportment’

It hasn’t helped that we’ve gotten tepid and arguably contradictory signals of these options from the Labor Department. In 2015, concerned that its prior guidance had discouraged plan sponsors from embracing “economically targeted investments,” the Labor Department issued a new interpretive bulletin, and while reiterating its consistent stance that the focus of plan fiduciaries on the plan’s financial returns and risk to beneficiaries must be “paramount” and that under ERISA, “…fiduciaries may not accept lower expected returns or take on greater risks in order to secure collateral benefits,” stated that “Fiduciaries need not treat commercially reasonable investments as inherently suspect or in need of special scrutiny merely because they take into consideration environmental, social, or other such factors.”

Now, while that arguably wasn’t a bright green light, it was hard not to see that an attempt to lower a barrier to ESG consideration that the Labor Department thought it had inadvertently erected with guidance in 2008. 

That said, about a year ago the Labor Department cautioned that “fiduciaries must not too readily treat ESG factors as economically relevant to the particular investment choices at issue when making a decision,” and that “it does not ineluctably follow from the fact that an investment promotes ESG factors, or that it arguably promotes positive general market trends or industry growth, that the investment is a prudent choice for retirement or other investors.” 

Sure, the Field Assistance Bulletin spent most of its text reiterating the standing notion that ERISA fiduciaries must always put first the economic interests of the plan in providing retirement benefits – but even a casual reading had to see the 2018 update as a pullback in the favorable view with which Labor seemed to view ESG just three years previously.

In fact, the 2018 Labor Department guidance noted that, in the context of a qualified default investment alternative (QDIA), a “decision to favor the fiduciary’s own policy preferences in selecting an ESG-themed investment option for a 401(k)-type plan without regard to possibly different or competing views of plan participants and beneficiaries would raise questions about the fiduciary’s compliance with ERISA’s duty of loyalty.”

Today’s ESG focus is, of course, different than what was once referred to as socially responsible (or by skeptics as socially responsive) investing, which tended to be reliant on negative screens – no guns, no tobacco, etc. The issue, ultimately, with ESG wouldn’t seem to be a disagreement with its general objectives, but perhaps uncertainty as to exactly which environmental, societal and governmental issues are the focus of a particular offering (and how that might change in the future), concern about the expense of an offering whose tenets demand active management, and yes – though there’s little indication that the DOL’s stance moved the needle much either way – confusion as to exactly how, as an ERISA fiduciary, they are supposed to weigh those factors. 

None of those issues would seem to be insurmountable to this category of investment – if it turns out that people really are willing to put their retirement money where their minds are. 

It remains to be seen if that will be the case.