Almost a decade ago, my friend and former colleague, Chris McKnett, gave a TED talk about the case for sustainable investing by focusing on environmental, social, and governance (ESG) issues and how companies address them. As he explains it:
Investors should also look at performance metrics in what we call ESG: environmental, social, and governance. Environmental includes energy consumption, water availability, waste, and pollution, just making efficient uses of resources. Social includes human capital, things like employee engagement and innovation capacity, as well as supply chain management and labor rights and human rights. And governance relates to the oversight of companies by their boards and investors.
Institutional investors, or people who oversee big pools of money like pension funds or endowments and foundations, have been debating whether to evaluate ESG in their investment decisions for years. Among institutional investors, including ESG factors in decision-making is not widespread, but it’s growing. According to a recent study, only 49% consider ESG when making decisions about how to invest their assets. However, this number has more than doubled since 2013 (back when Chris gave his TED talk), and another 40% are considering incorporating ESG into their processes going forward.
But what about the rest of us? Is ESG on the radar of individual investors? Are people thinking about ESG when they choose investments in their retirement plans offered by their employers? According to a survey published last year, 37% of participants were aware that their defined contribution (DC) plans offered ESG investment options, and 40% did not know. Of those that knew about the ESG options, 9 out of 10 said they’ve chosen to invest in them. Still, ESG investment options are not widely available in DC plans. The investment consultant, Callan, reported in its DC Survey that only 13% of DC plans include an ESG investment option, and usage of those options is low (the average allocation is 1.2%).
The reason for this may be partly a result of policy and partly due to human behavior. Guidance from the Department of Labor to employers and plan sponsors offering DC plans has changed over the years based on views held by presidential administrations. For example, the Biden administration recently proposed a rule that many believe would make it easier from a fiduciary perspective for retirement plan sponsors to include ESG funds in their DC plans. While not yet in effect, this proposed regulation is generally viewed as friendlier to ESG investing in DC plans than the stance taken by the Trump administration. Additionally, a huge number of Americans (64% by Vanguard’s estimate in its annual study, How America Saves) use professionally managed funds like target-date funds, target-risk or balanced funds, or managed accounts to invest their DC savings—often because their funds are automatically invested by their plan sponsors if they don’t choose their own investments when signing up for, or when automatically enrolled in, their retirement plans. According to Vanguard’s research, “six of every 10 dollars contributed [to DC plans in 2021] were invested in target-date funds (TDFs).”
Even so, in recent years, large asset managers like State Street Global Advisors and BlackRock have used their clout to vote on behalf of investors in their funds to advance the representation of women among boards of directors and reduce the impact of climate change, among other issues. Even index providers like MSCI and FTSE Russell—who determine which companies are included in the index that a fund tracks (or attempts to beat)—play a role in determining how capital gets allocated to companies, recently removing Russia from many widely used indices because of its uninvestability.
Helping Participants Understand ESG Options in Your DC Plan
As interest in ESG continues to grow, the industry trade association, Defined Contribution Institutional Investment Association (DCIIA), has developed a wealth of white papers and webinars to help plan sponsors navigate the many decisions tied to making ESG funds part of their retirement plan’s menu of investments. As part of this effort, I collaborated with two fabulous thought leaders in this field, Stephanie Moersfelder from Impax Asset Management and Bonnie Treichel from Endeavor Retirement, to create a framework designed to help plan sponsors communicate about ESG to plan participants. Our brief, nine-slide framework outlines action items, including how to:
- Integrate sustainability rankings into performance reports and participant statements
- Leverage change as an opportunity to broadly educate participants
- Enlist the support of others (external providers and internal partners) to create effective communications
Like any investment option in a DC plan, plan sponsors cannot selectively promote one choice over another to their people. Be sure to keep this in mind when developing your communications and education strategy.
View our framework for practical ideas about how to communicate about sustainable investing in your DC plan.
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