Demand for environmental, social and governance (ESG) strategies is strong among investors and research supports the case for integrating ESG factors into the defined contribution investment decision-making process, yet the industry still appears hesitant, according to two new reports.
In “Sustainable Investing in Defined Contribution Plans: A Guide for Plan Sponsors," the Defined Contribution Institutional Investment Association (DCIIA) sets out to provide a base level of knowledge about sustainable investing and integration by focusing on areas that have historically been misperceived. The paper explores the two primary ways for plan sponsors to implement sustainable investing in DC plans:
- adding ESG-themed fund options into the fund lineup or self-directed brokerage window; and
- considering ESG factor integration in investment processes during manager evaluation.
DCIIA explains that sustainable investing is a framework for investors to examine companies from the perspective of long-term viability and ethical impact, which allows investors to evaluate a company’s exposure to, and its ability to address, ESG-related risks and opportunities. The authors observe that sustainable investing “can take many shapes” along a spectrum focusing on financial and social benefits, with the possibility of many labels falling under the ESG umbrella.
“Historically, ESG-related investing was typically a trademark of socially focused collectives and unions. Today, sustainable investing is affiliated with more than just values-based organizations, and it is increasingly independent of moral stances,” the paper explains. As such, an investor can pursue a sustainable strategy anywhere along the spectrum:
- seeking strategies that integrate ESG factors from a risk/return perspective;
- looking for those that target specific social or environmental goals; or
- incorporating elements from various approaches into one investment or program.
Myths and Confusion
As to the purported myth that there is insufficient research, the paper contends that many academic and industry studies “provide a clear rationale” for incorporating ESG factors into investment decision-making. Academic studies that have analyzed the relationship between ESG factors and performance have found a strong correlation with alpha, beta and portfolio value, the paper notes.
DCIIA’s paper further addresses the notion that adding an ESG-themed fund or requiring ESG integration is incompatible with fiduciary responsibility. The authors note that the recent series of Interpretive Bulletins issued by the DOL has led to confusion “due to a lack of clarity in the language and an inconsistent tone over the course of different administrations.”
While IRS Field Assistance Bulletin (FAB) 2018-01, issued in April 2018, seeks to establish “high-level guardrails” on the intent and costs involved in ESG factors and shareholder engagement, the paper further emphasizes that the “analytical architecture” of Interpretive Bulletin (IB)-2015 and IB-2016 remains unchanged and that ESG factors remain an appropriate component of a prudent investment decision.
The paper further addresses the notion that DC plan participants are not necessarily interested in seeing their investments aligned with their values. Because these strategies have only recently become more mainstream, broad participant demand for ESG integration could be considered “latent, versus weak,” the paper notes.
Consequently, using assets in ESG-themed mutual funds and the adoption of ESG-themed mutual funds within DC plans as indicators of participant views on sustainable investing is not appropriate, the paper contends. It notes, instead, that when sustainability is framed as more than just ESG-themed funds, investors agree that these factors should be considered in their investment options.
Strong Tailwind, But Lack of Standards Hampering ESG Adoption
Additionally, a new report by Natixis Investment Managers seems to corroborate some of the contentions in DCIIA’s paper. It finds that three-quarters of individual investors want their investments to align with their personal values and more than half (56%) of investors globally – including 61% in the U.S. – believe companies that demonstrate higher integrity will outperform.
The study, “Looking for the Best of Both Worlds,” is based on surveys Natixis conducted globally with 12,375 financial professionals, individual investors and institutional investors about the views and issues that drive their decisions on ESG investing.
Natixis found that the potential to support personal values while meeting portfolio objectives may be a critical reason why demand for ESG strategies is strong among investors. But the findings also reveal investors’ need for clarity on how ESG is implemented. According to the survey:
- 60% of investors globally say they already actively invest with the purpose of making a positive social or environmental impact (including 71% in the U.S. who say it is important to them to be able to invest according to their personal values);
- 56% of investors globally say they actively avoid investing in companies that go against their personal values; and
- 56% of institutional investors believe there is alpha to be found in ESG, but lack of track records and difficulty measuring performance are cited as main challenges.
But despite positive perceptions and growing demand for investments that reflect their values, Natixis found that investors are not blindly accepting when it comes to ESG investments. Many want more information to support their decisions – only 50% of those in the U.S. say they have the information they need to make socially responsible investment decisions.
For financial advisors, closing the information gap could be a significant step to enhancing long-term client relationships, Natixis suggests. The firm notes that 88% of advisors globally say their key to success is their ability to demonstrate value above and beyond asset allocation. Being more attuned to client values could be a clear point of distinction for advisors and ESG investments are an important way for them to differentiate themselves, the firm emphasizes.
But despite the large number of investors who think it is important to align their investments with their values, only 28% of advisors in the U.S. believe clients have asked more for ESG investments in the last 12 months. Advisors may be slow to recognize an important investment trend: With investor interest increasing, just 17% of advisors in the U.S. think they need to improve their ability to understand and explain ESG to their clients.
What’s more, while they may feel comfortable with their understanding of ESG, many advisors in the U.S. have a limited view of what ESG investing means. When asked to define ESG, a third say it means negative screening, 20% describe it as incorporating companies’ ESG decision-making into the investment process, 19% impact investing and 19% thematic investing. To properly advise their clients, financial intermediaries themselves need a better, clearer understanding of ESG. That said, 62% of U.S. advisors currently say they are more likely to recommend ESG products to their clients if there is better data and reporting on these investments.
