With studies showing that environmental, social and governance (ESG) factors can be financially relevant investment considerations, a Jan. 13 NAPA webcast sponsored by MFS Investment Management offered thoughts on where plan fiduciaries should start.
In “A New Year, a New Approach to ESG Integration,” MFS’s Jessica Sclafani, Director and Defined Contribution Strategist, and Vish Hindocha, Senior Managing Director and Global Head of Sustainability Strategy, along with ARA Chief Content Officer Nevin Adams as moderator, shared their perspectives on a path forward for engaging with plan sponsors and developing an ESG investing philosophy.
Sclafani explained that ESG has been a huge topic for investors globally, but that a lot of the discussion in the retirement industry as it relates to ESG has fallen into two camps: product focused, or ivory tower discussions that are abstract and intangible.
“What I’ve found working with investors all over the world—even those large institutions that have been supposedly doing this for some time—is that everyone is struggling with how to make an honest start and maintain progress. But it’s clear that there are also exciting opportunities to differentiate, for those who are willing to do the work,” Hindocha emphasized.
Competitive Advantage
One way to think about ESG that doesn’t get talked about enough is that it offers a potential competitive advantage versus other advisors, Sclafani noted. The DC strategist observed that in December 2021, Cerulli Associates published data from a survey of financial advisors showing that 43% of respondents are waiting for clients to bring up ESG before discussing it. “This feels like a reactionary approach that opens the door for your competitors to talk to your clients about this big, complex and sometimes overwhelming topic before you get to it,” Sclafani observed. “We are encouraging advisors to get in front of ESG—not in a way that pushes a plan to implement ESG, but rather to get up to speed so that as a fiduciary the plan sponsor can make an informed decision one way or another.”
Another aspect of the Cerulli data was that nearly one in five respondents answered that they don’t discuss ESG with clients because they don’t believe in it, Hindocha observed. “I think beliefs are important, but it is crucial how they are framed. For example, most people would agree that understanding how electric vehicles will disrupt traditional car sales is an important consideration when looking at the auto industry.”
Regulatory Hurdles
When Adams suggested that some advisors may be holding back on talking about ESG because of the challenging regulatory environment, Sclafani acknowledged there has been a “ping pong” dynamic from the DOL in recent years that has not been helpful. She suggested that an approach of ESG integration that is focused on material ESG factors will be the best path forward for plan fiduciaries and one that aligns with the DOL’s October 2021 proposed rule. And while the rule is not final, the DC strategist believes the DOL is making clear that ESG factors can be material inputs into the investment decision-making process, similar to other “traditional” risk-return factors.
“I think all of the regulatory movement on this topic has created ‘ESG anxiety’ for some plan sponsors—so they might not want to talk about it, but they are anxious about what they need to be doing as a fiduciary on this topic,” Sclafani explained. She further noted, however, that they are not saying you have to incorporate ESG into retirement plans, but that plan fiduciaries should make an informed decision.
Practical Implementation
Turning to implementation, Adams observed that another barrier that seems to be limiting ESG in retirement plans is how a plan fiduciary should know what ESG issues (e.g., climate change, fossil fuel usage, human rights, gender equality, etc.) to focus on in the investments offered to participants.
While noting that is a question they hear consistently, the MFS panelists suggested it is the wrong question to be asking, explaining that a values-based approach is very difficult to implement within a retirement plan, as values are highly dependent on the individual. “The takeaway here is really twofold from one plan population to the next—you will encounter different ESG priorities, and then even within a single plan population, you won’t be able to satisfy everyone because people’s values are highly individualized,” Sclafani emphasized.
“And even if you could know at a single point in time, you would be out of date pretty quickly, given how quickly new issues emerge and how they evolve,” added Hindocha. “The question you can ask yourself, instead, is how can you best prepare for this in a way that will future-proof your fiduciary responsibility as much as possible.”
Regarding how to get started, the MFS panelists noted that in their conversations with plan sponsors, they see a need for an initial education session, addressing the “what, why and how” of ESG from a DC plan sponsor perspective. “One thing that became really clear to me after doing this presentation all throughout 2021 is that ESG means 100 different things to 100 different people so this can be a helpful level-setting discussion for a plan committee to have,” Sclafani noted.
Organizational and Participant View
Once the plan committee feels it has a working understanding of ESG factors and how DC plans can implement ESG investment strategies, it can be helpful to discuss the organization’s view, the MFS panelists explained. Sample questions could include:
- How has the organization positioned itself to the public and its customers in regard to ESG?
- How might the organization’s ESG beliefs be applied to the retirement plan?
- What does the employee population think about ESG?
“These kinds of questions can help a plan committee develop an ESG philosophy and ultimately determine if offering investments that consider ESG factors in the retirement plan aligns with their goals for the retirement plan,” Sclafani noted.
Another aspect of the “demand for ESG conversation” is the participant perspective. The panelists pointed to a 2021 MFS Global Retirement Survey showing that 72% of U.S. active DC plan participants are interested in seeing more investments that consider ESG factors. The survey data also showed that about 70% of participants would increase their contribution rate if they had access to investments that considered ESG factors—a finding they noted was particularly true for younger generations.
To help plan fiduciaries better understand and even quantify their participant population’s sentiments around ESG, the panelists explained that they created a brief survey of six questions that can be administered to all employees eligible to participate in the DC plan. Data collected from the survey can help the plan committee quantify if their specific employee population is interested in their retirement investments considering ESG factors and issues, they explained.
“We know this will look different from plan to plan, and it’s really at this point that the advisor can really showcase their value and expertise by supporting the plan committee in determining what would work best for their specific plan,” Sclafani emphasized.
Finally, when asked by Adams about how to go about adding investments that consider ESG factors, the MFS panelists explained that it can be difficult to know what asset managers are doing it genuinely, but responses to RFPs can shed a lot of light. “Sometime reviewing asset manager responses to the ESG RFP questions can turn into an ‘ah-ha’ moment for the plan, as they may come to learn that the plan is already offering investments that consider ESG—it’s just that ESG isn’t featured in the naming convention of the fund,” Sclafani noted.
