DOL Guidance on ESG Investments

Nicholas Zaiko, CIMA

Senior Consultant

Bridgebay Financial, Inc.

www.bridgebay.com

Millennial Interest in ESG Investments

A recent survey by Natixis found that 82% of plan participants want their investments to reflect their personal values. Millennials account for 77% of plan participants surveyed that want more socially responsible investments in their retirement plans.   In fact, 71% stated that they would contribute or increase their retirement plan contributions if their investments were socially responsible.  Amid this growing demand from plan participants, the DOL has provided guidance on ESG (environmental, social and governance) investments for retirement plans.

DOL Guidance on ESG Investments

In response to this increased demand for ESG investments, especially, for retirement plans, the Department of Labor (DOL) issued some guidance on April 23, 2018.  The Field Assistance Bulletin No. 2018-01 (FAB) updates previous DOL Interpretive Bulletins (IBs) IB 2015-01 and IB 2016-01 regarding ESG investments.

This FAB is of interest to plan sponsors as they respond to participant requests that their retirement plans include ESG investments. Essentially, the DOL guidance reinforces that plan sponsors should apply the same due diligence process in selecting ESG-type investments for retirement plans.

IB 2015-01, highlighted that in the process of investment selection when competing investments are economically equivalent, then plan fiduciaries can use ESG-related considerations as tie-breakers for an investment choice.

IB 2016-01, plan fiduciaries may engage in shareholder proposal activities if it may improve the corporation’s investment value, after considering the associated costs. It also indicates that Investment Policy Statements can include criteria for ESG factors, screening tools, metrics, or analyses to evaluate an investment.

The DOL’s FAB emphasizes that fiduciaries should prioritize the economic interests of the plan in providing retirement benefits.  It should not dramatically forego investment returns or assume greater investment risks to meet ESG criteria.  It is not mandatory that investment policy statements contain guidelines on ESG investments or integrate ESG-related tools to comply with ERISA.  However, it may still be best practice to document acceptable criteria for ESG investments so that fiduciaries understand the criteria for quality ESG investments.  The DOL cautions fiduciaries against routinely incurring substantial plan costs to actively sponsor proxy fights on environmental or social issues.

Types of ESG Funds

The DOL identified different types of ESG funds such as Socially Responsible Index Fund, Religious Belief Investment Fund, or Environmental and Sustainable Index Fund.  There ae also conventional funds not explicitly identified as ESG funds that consider ESG factors in their selection criteria and portfolio management.

ESG Investments in 401(k) and 403(b) Plans

The DOL confirmed that including ESG funds in retirement plan investment fund menus that reflect the participants’ social value is permissible. Like any other fund selected for a retirement plan, it should be prudently evaluated, professionally managed, and well diversified.  The inclusion of ESG funds should not exclude other non-ESG funds that provide additional diversification.

ESG Investments in QDIA

The FAB addresses the selection of a qualified default investment alternative (QDIA) to which participants may be automatically defaulted.  The selection of a QDIA is not the same as simply adding an ESG fund to the investment line-up where participants can make choices.

The selection of an ESG-themed target-date fund as a QDIA would not be prudent if the fund provided a lower risk/return profile than non-ESG target-date funds.

DOL discourages the use of ESG-only investment options as QDIAs. However, this does not preclude the selection of a QDIA that has an ESG-fund in the mix of other non-ESG funds as part of the underlying funds.

Investment Policy Statements

The FAB indicates that when the retirement plan’s Investment Policy Statement (IPS) includes guidelines for ESG investments, an investment manager is still responsible to determine if the ESG factors in the IPS are consistent with ERISA.  At times, investment managers may not be able to comply with the IPS if it is not consistent with ERISA.  Best practices, however, would be for the investment manager to point out these inconsistencies to the plan fiduciaries rather than blatantly violate the IPS.

Proxy Voting and Shareholder Engagement

The FAB emphasizes that the costs of shareholder engagement and proxy voting is important and it would be inappropriate for ERISA fiduciaries to routinely incur significant plan expenses.  This is consistent with IB 2016-01 that indicates that ERISA plans involved in proxy voting and shareholder engagement may comply with a fiduciary’s obligation under ERISA.  It also cautioned that fiduciaries should not engage in costly fund advocacy or actively sponsor expensive proxy battles on environmental or social issues concerning their specific corporate stock holdings.   

GAO Report in 2018

The Government Accountability Office (GAO) is expected to issue a report in 2018 on how US retirement plans should handle ESG investments and how other countries handle these investments.

Considerations for Plan Sponsors

Like any other investment decision, plan fiduciaries should maintain well-documented records regarding their evaluation, selection and decision to invest in an ESG fund.  They should consider the ESG investment based on its performance, reasonable fees, diversification, quality of the underlying investments, and sound investment principles.  Investments should not be solely focuses on the potential social benefit and impact.  Interestingly, as more investors embrace ESG factors in their investment selection, demand will typically rise for quality ESG companies which in turn may raise the performance of those investments. 

401(k) Plan Survey 2018 from PSCA Summary

Nicholas Zaiko, CIMA

Senior Consultant

Bridgebay Financial, Inc.

www.bridgebay.com

The Plan Sponsor Council of America’s 60^th Annual Survey of Profit Sharing and 401(k) Plans released on February 12, 2018 highlighted some interesting developments in the defined contribution market.  The survey consists of responses from 590 plan sponsors that offer defined contribution plans to their employees.    

Plan Fiduciary Advisors

The use of independent, fiduciary advisors has grown with 69.5% of plan sponsors stating that they retain independent advisors that are separate from their recordkeeper.  Nearly 36% use an ERISA 3(21) fiduciary advisor that has non-discretionary authority, providing advice to the plan sponsor with the employer making the final decision.  About 20% use an ERISA 3(38) fiduciary advisor that has full discretionary authority to select, monitor and make investment decisions.  The remaining respondents were not sure if their advisor was a co-fiduciary.

Investment Policy

Investment policy statements are in place for 87.6% of defined contribution plans.  Plan monitoring is conducted quarterly for 61.4% of plans with 19.6% of plans, mostly small plans, conducting annual reviews. 

Automatic Enrollment

Automatic enrollment is now offered by 59.7% of plan sponsors including large and small employers.  This plan feature is most common in plans with over 5,000 participants with 70% of those plans offering automatic enrollment.  Plan sponsors have been increasing the default deferral rates so that over 59.7% of plan sponsors now automatically enroll participants at over 3% of salary.  One-third of plan sponsors are defaulting participants at 3% of salary. Target date funds are used as the QDIA or default option by 63.7% of plan sponsors surveyed.

Deferral Rates

The most frequently used default deferral rate for automatic enrollment has been 3% of pay since the Pension Protection Act.  Plan sponsors are gradually transitioning to higher default deferral rates to improve savings.  More plans are now auto enrolling participants at rates more than 3% of pay with 35.2% of plans using a 6% default rate, and 40.2% using more than 6% default rate.

Auto Escalate Deferrals

Three-quarters of plans auto escalate by 1% each year, while 8.6% auto escalate by 2% and 5% auto escalate by 3%.  Plans that cap auto increases at 10% represent 41.8% of plans, while 19.4% cap it at more than 10%.

Automatic increase of default deferral rates has become widely accepted with 73.4% of plans increasing deferral rates over time.  About 33% of respondents increase the default deferral rate for all participants, 12% auto escalate deferral rates for participants that are “under contributing”. Another third of plans require the participant’s election to auto increase. 

Suggested Savings Rates

Plan sponsors that provide a suggested savings rate to participants represent 28.4% of sponsors surveyed.  The most often savings rate suggested was 6% of pay.  Some plan sponsors, 17.5% stated that they suggested savings rates higher than 10%.

Roth Contributions

The Roth contributions (after-tax) have become more readily offered as an option for participants with 63.1% of plans now offering the Roth 401(k) option in addition to the traditional 401(k) plan. 

Employer Contributions

Employer contributions have increased since the financial crisis to an average of 4.8% of participants’ pay. 

QDIA

After the Pension Protection Act most plans, nearly 70%, use a qualified default investment alternative (QDIA). The most popular QDIA is target date funds. 

The target date funds are offered by 73% of the plans surveyed of which 63.7% of plans use target dates as the QDIA or default investment option.  Plan assets in target date funds represent 22.2% of plan assets.  Of the plans using target date funds, 86.4% of the plans use off-the-shelf target date funds. Larger plans with 5,000+ participants often used customized target date funds. Actively managed target date funds represent 59.6% of the target date funds used while 40.4% use index or passively managed funds.

Investment Options and Allocations
Plans offer an average of 19 funds, a number that has remained steady since 2011. The funds most commonly offered are indexed domestic equity funds (87.3% of plans), actively managed domestic equity funds (85.3% of plans), actively managed international equity funds (83.7% of plans), and actively managed domestic bond funds (78.8% of plans). 

Managed accounts or professionally managed assets are offered by 40% of plans sponsors with the majority of plans with 5,000 participants.  In-plan annuities were offered to participants in 10% of the plans surveyed. 

The highest concentration of participants’ assets were actively managed domestic equity funds (22.9%), target date funds (22.2%), indexed domestic equity funds (13.5%), stable value funds (8.1%), and balance funds (4.3%) of plan assets.

Participant Education

The most frequent reasons given by plan sponsors for providing participant education are to:  

• Increase participation (71.4%)
• Improve appreciation for the plan (65.8%)
• Increase savings and deferrals (62.7%)

Plan sponsors use a variety of approaches to educate their participants including the following:

• Email (64.1%)
• Seminars/workshops (55.3%)
• Enrollment kits (46.4%)
• Internet/intranet (42.7%)
• Fund performance sheets (30.9%)

Participant Investment Advice

About 35% of plan sponsors offer their participants investment advice using third party advisors.  Approximately 25% of participants use the investment advice service when it is offered by plan sponsors. Of the advice providers, 30.8% are registered investment advisors (RIA), 28.8% are certified financial planners (CFP), and 20.2% are on-line or web-based providers. 

The most frequently used methods for providing advice are one-on-one counseling (68.5%), on-line advice (45.7%) and telephone representatives (48.7%).

Eligibility

Employers responded that over 90% of employees are eligible to participate in their defined contribution plans. About 65% of employers permit part-time employees to participate in the plan. Immediate eligibility is offered by 58.8% of employers surveyed. That means that employees can begin to participate in the plan as soon as they are hired.  Of employers that provide a matching contribution, 47% provide immediate eligibility to receive the match. Another 31.9% of plans that make non-matching contributions provide immediate eligibility to participants. 

The average percentage of eligible employees who have a balance in their plan is 88.7%. The average salary deferral for both 401(k) and Roth contributions for all eligible participants was 6.8%.

Loans

Most plans (88.9%) allow participants to borrow against their account balances.  Almost 25% of plan participants have loans against their balances. Plans that limit the number of loans outstanding to one loan at a time represent 55.1% of plans while two loans permitted are 36.3% of plans.  

Fees

The survey found that plan recordkeeping and investment fees are generally paid by the plan.  However, other plan expenses such as legal, audits, consulting, and education are paid by the company rather than the plan.  Asset-based fees for recordkeeping and administration are paid by 43% of plans while 34.4% of plans pay a per capita or flat fee per participant.  Over 50% of plan sponsors conduct an annual review of fees while 30.3% review fees more often.