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.
