In a divided Washington, DC, retirement policy has generally been an area of common ground. However, one thing that is likely to change with the new presidential administration is the U.S. Department of Labor’s (“DOL”) position on funds that invest based on environmental, social and governance (“ESG”) factors. In this context, a key question for defined contribution (“DC”) plan sponsors will be whether to add such funds to menus; and retirement plan advisers (“RPAs”) may wonder if they should advocate for ESG funds at a time when sponsors have an array of other important issues to contend with.
In the Trump years, the DOL indicated that fiduciaries could not use any criteria other than financial returns to evaluate plan investments, leaving funds that considered ESG issues as part of their investment strategy subject to skepticism. However, the Biden administration has indicated that it will not enforce this “pecuniary rule,” although it could be a year or more before a new rule is promulgated.
Hurdles
Although ESG investing generally has been gaining traction in the U.S., it remains much more popular in Europe, where some governments have mandated that pension plans invest a certain percentage in ESG funds—something that appears unlikely in the U.S. and is almost unthinkable for DC plans. At this point, according to a recent study by PGIM and Greenwich Associates, only 24% of DC plan sponsors offer or are taking action to offer ESG funds. This is still better than the percentages offering alternative, real estate and hedge funds, but shows shared reluctance based on concern that participants lack the sophistication to prudentially choose among more esoteric investments.
And then there is the question of what form of ESG vehicles should be included, whether standalone investments, as part of a plan’s professionally managed products like a target date or managed accounts or as a plan’s default option or QDIA.
The answer may depend on what problem plan sponsors and/or their RPAs are trying to solve: Are their socially conscious participants, especially millennials, demanding more responsible investment choices? Do the directors or senior management think this is important? Are nonprofits with 403(b) plans more likely to adopt ESG investing? If ESG funds underperform, will the fiduciaries be at legal risk even if they follow DOL rules? Will there be differences in uptake depending on where the plan is located and the nature of local politics?
Selectivity Is Key
While offering or even advocating for ESG funds may be a personal passion for some RPAs, it may not be for many DC plan sponsors. So, if volume is the goal, I believe RPAs need to be selective when advocating for ESG investments with prospects and clients. If the goal is to acquire like-minded clients, leading with or advocating for ESG to all plan sponsors may not result in more plans under management, but it could result in carving out a niche for that RPA. This, in turn, may lead to more clients, depending on the geographic location or whether the prospecting focus is on nonprofits or an industry where ESG ideas may resonate.
Regardless of their focus, I believe it would be wise for all RPAs to understand ESG investing, given that the new administration will likely make it easier to place them on DC plan investment menus. At a minimum, RPAs should question clients and prospects about their appetite for ESG funds and be ready to implement them, at least as an option.
