Take everything you think you know about Environmental, Social, and Governance (ESG) investing and throw it out because the wave is here, according to a Sept. 11 workshop session at the 2020 NAPA 401(k) Cyber Summit.
“This isn’t just for hippies; this is for everyone. And it’s time to really think about ESG and how it applies to your plan sponsors and participants, and how you should be incorporating it into your practice,” says Bonnie Treichel, Principal and Co-Founder of ZUNA.
Treichel was joined by Neal Weaver, CEO of LeafHouse Financial, and Adrian Ramirez, Senior Investment Analyst at LeafHouse where they provided an overview of ESG investing, the current legal framework, recent activity by the Department of Labor and how you can apply ESG to your advisory practice.
When you look at the flows into ESG investments, Treichel acknowledges that the numbers have been relatively flat for several years, but she points to a big jump from 2018 to 2019, where flows rose to about $20.6 billion, according to Morningstar data. And while that’s not that much in the retirement sphere, she suggests there’s a lot of opportunity for growth, particularly given the growing interest across the country among both participants and plan sponsor clients.
But why ESG now? Weaver suggests there’s a lot of pent-up demand, as his organization has seen a lot more interest, not just from advisors, but also from clients you would not typically associate with ESG investing. There also has been an increase in reputable third-party providers that can provide data in a transparent way, which his firm couldn’t do before from a due diligence standpoint, because companies didn’t disclose this type of data, he explained.
As to reframing the thinking, Weaver used an example of an oil company that you wouldn’t associate with being a champion of environmentalism, but noted they may have a great track record on social or governance issues, such as diversity inclusion policies or community involvement. “They might actually check more boxes than you would have thought, and so, this is about reframing under the sense of a fiduciary blanket,” Weaver noted.
To that end, Ramirez suggests there is still a lot of educating that needs to be done, as plan sponsors, advisors and participants are very confused on the definitions and what they’re trying to achieve. Below the surface, he explains, there’s a sub-layer of investment screening methodologies that aren’t often talked about, which may lead to the confusion in nomenclature. For example, there’s best-in-class screening, negative or exclusionary screening, impact investing, activist investing and ESG integration, which, he emphasizes, is more robust and is the key focus right now that’s driving the growth.
Proposed Guidance and Inquiries
Turning to the DOL’s proposed guidance, Treichel observes that the proposal has been quite controversial, with many of the comments on the negative side. She believes a lot of it has been political posturing, but that demonstrates the wide array of interest in ESG.
So, is the proposal really that different from the 2018 guidance, and does it mean you can’t do ESG? Treichel suggests that, under the proposed rule, advisory firms will still be able to recommend ESG investments. “Fiduciary duty would be satisfied when the fiduciary has selected investments based, and this is what’s the key, solely on their pecuniary factors or financial factors and not on the basis of these non-pecuniary or nonfinancial factors,” she explains, adding that she doesn’t believe it’s that far of a departure from what is already an existing obligation.
Treichel further notes that where she believes the DOL may have gotten itself in a little bit of trouble is in relation to the QDIA or the default. “I think where it’s problematic in the proposal is that consistent with my interpretation of the 2018 guidance, the DOL doesn’t think that, as the default or as the QDIA, that ESG is okay, but the problem is, I don’t think there is a good or really any definition as to what ESG is in the proposal,” she explains. Moreover, she notes that there’s not a clear distinction as to why if you’ve done a prudent selection and monitoring process on the DIA and you do the same thing in the QDIA, why one would be okay and not the other.
Another interesting development, according to Treichel, was the letters sent out recently by the DOL asking questions about ESG investments that were very specific in nature. Among the questions to plan sponsors were whether they have ESG investments, and if so, about the documentation, investment policy statements, the selection and monitoring of those funds, and proxy voting.
Weaver noted that his firm, in fact, received one of the letters. “We thought of it in a very positive light because this allows us to show the regulators what can be done with a system where there are guidelines that we are following and there are systematic things that we’re putting in place that can justify the ESG investment,” he explained. He notes that they want to give the DOL as much data as possible, so that when the department issues its final ruling, “it’s with as much information as they can get from people on the ground that have a stake in the game.”
Educating Yourself
In fact, as was announced in the opening session of the 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 in general. The ESG program is specifically designed to educate advisors about what ESG is and how they would apply it in their practice and why they should do this if they so choose. (Look for more on that effort in the near future.)
As for takeaways, Weaver suggests that a first step for advisors is to assess where you are in your practice, not only just today, but 10 to 15 years down the road. And part of that assessment process is educating yourself about ESG investing, he emphasizes.
In addition, he suggests reviewing the investment screening process to make sure that it is value driven for your practice. Consider also how you are going to document all this in relation to financial factors and how you are you going to put this into your investment policy statement.
“And I think obviously all of this is under the guise of watching whatever the DOL decides to do, and what happens after November and whether or not they’re going to keep on the same track,” he notes.
