Demand, data and diversification are the three elements required for ESG investing to flourish within DC plans. For sponsors, monitoring these dimensions will offer insight in to the rates of institutional and individual change.
While environmental, social and governmental (ESG) investing acceptance and application in the United States has trailed global trends, there are signs suggesting a scaling shift. Here we focus on three trends that sponsors should watch as early indicators that an ESG era is dawning.
ESG and retirement investing seem likea natural fit, because both disciplines view the world through a particularly long-focus lens. But many sponsors have yet to make the connection. A July 2018 study by New England Pension Consultants (NEPC) found that 88% of U.S. plan sponsors have yet to incorporate ESG into their defined benefit (DB) or defined contribution (DC) plans.1 This figure aligns with Callan’s DC Index™, showing that only 16% of U.S.DC plans offer a dedicated ESG option.2
In the NEPC survey, sponsors report several common concerns
In addition, sponsors also seem to be waiting for clearer public policy guidance. In April 2019, an Executive Order (EO) directed the Department of Labor (DOL) to examine data filed by retirement plans under ERISA for any discernible trends in investing or proxy voting in the energy sector. The DOL was also ordered to revise or issue guidance in order to “promote energy infrastructure and economic growth.” The evident purpose of the EO is to apply extra scrutiny to any application of ESG principles that might disfavor retirement plan investments in the petroleum sector. It’s possible the EO could slow the adoption of ESG, but some observers view the order as mostly symbolic. Its practical effect may simply be to abate activist investor spending by requiring shareholders to prove the materiality of ESG factors. The administrative debate will probably continue until a compromise emerges. In the meantime, it’s a conversation that merits close monitoring.
Three industry indicators could create a more welcoming environment for ESG integration:
1. New populations demanding new solutions. Yesterday’s retirement plans need retooling to meet the unique needs of Millennial and Gen Z workers —including their long-time horizons. At State Street, we already apply unique investment approaches by life stage. For younger participants, for example, our Target Retirement 2060 Fund stacks a high equity allocation on top of a small-and mid-cap tilt and long U.S. bonds to maximize opportunity over the long run. This philosophy could extend to include ESG options for younger savers in order to hedge against downside risks that previous retirees never had to consider —from superstorm damages to the impact of droughts on textile manufacturing to rising global obesity costs.In addition, as younger generations move to center stage in the American economy, their concerns about investing in socially responsible ways are likely to bring ESG considerations further into the mainstream.
2. Better, more consistent ESG data. ESG investors have long struggled to find a consistent approach to defining whether an investment aligns with an ESG philosophy. Now, asset managers are pursuing solutions to help. For example, State Street is working to create a clearer and more consistent foundation for ESG data, combining multiple data sources with active company engagement to deliver standardized, transparent ratings and reporting. This new in-house ESG scoring system, called R-Factor, collects raw company metrics from multiple data providers and scores more than 5,000 companies on a consistent scale of 0 to 100. Its goal is to take the guesswork out of ESG reporting, easing the adoption of ESG strategies.
3. The growing popularity of alternatives. Sponsors’ interest in alternative asset classes is increasing. As we discussed in an earlier issue of The Participant, plan sponsors may consider dipping their toe into ESG using an approach similar to the way they are incorporating real assets and other alternative asset classes. Currently, ESG prevalence in DC plan lineups is on par with emerging market equity, REITs and global fixed income. As demand for alternative asset classes grows, the rising tide of popularity is likely to buoy ESG strategies as well.
The pace of DC ESG adoption has been gradual, slowed somewhat by muted domestic demand and confusing policy guidance. But today, demand worldwide is growing, the data are improving and the diversification potential of ESG is winning wider recognition. Prudent plan sponsors need to keep a close eye on these three elements in order to monitor market momentum —and avoid being caught by surprise.
For young workers, the world of tomorrow may feel unimaginable, though ESG investing could help prepare participants for the unpredictability by protecting them from new risks and reducing the likelihood that certain perils will ever come to pass. By thoughtfully considering ESG approaches, DC plans could help workers build a more resilient retirement strategy —as well as a more resilient world in which to retire.
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1 New England Pension Consultants, “Defined Benefit and Defined Contribution Plans Both in Beginning Stages of Incorporating ESG Investing,” July 23, 2018. https://www.nepc.com/press/nepc-survey-defined-benefit-and-defined-contribution-plans-both-in-beginning-stages-of-incorporating-esg-investing
2 Callan, “Most DC Plans Don’t Feel ESG’s ‘Good Vibrations,” May 29, 2018. https://www.callan.com/esg-dc/
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Exp: June 30, 2023