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Retirement plan sponsors interested in making these strategies available within their 401(k) investment menus can certainly do so. That said, plan fiduciaries should be aware of a few important considerations:
1. Regulatory change: The retirement plan industry has faced changing regulatory guidance on this topic. Most recently, the Department of Labor (DOL) has proposed new guidance for retirement plan sponsors considering ESG investments for their plans. The DOL is now in the process of finalizing the regulation after the required comment period.
2. Evolving investment ratings: The ESG investment rating landscape also continues to evolve. This can create a challenge for plan sponsors trying to take a holistic view of their investment menu. Investment firms rely on data from ESG rating providers to assist them in assessing a company’s policies and operations related to ESG factors. Unfortunately, there can often be a meaningful diversion of ratings for any single company across providers, which in turn leads to differences in the providers’ fund-level ESG ratings. Several factors contribute to these differences in ratings:
- Corporate reporting frameworks are still working to keep pace with the demand of investors and stakeholders to provide consistent and robust ESG-related data for companies. At the present time, there are no standardized ESG disclosure rules, which makes it challenging to identify and deliver pertinent and accurate data.
- ESG Company/Issuer rating providers consume this often divergent and incomplete company-level reported data, in turn, may assess it differently as they formulate their ESG ratings. The ratings may also be affected by other differences between ESG Rating providers, including how they source the data, their measurement systems and methodology (e.g. differences of issue weights, industry classifications and different peer groups for benchmark ranking statistics).
- Fund-level ESG ratings are generally a roll-up of a provider’s issuer-level ratings based on the weight of each holding in the portfolio, but most providers do not offer ratings that assess the fund manager’s intent and the extent to which they actually incorporate ESG factors in their portfolio construction process.
There are, however, changes underway to help address these challenges. For example, a number of standard setting firms have pooled their efforts recently to improve the corporate reporting process with the goal of creating a comprehensive corporate reporting system. For example, in the piece “The cost of transition: Is sustainable investing data credible?,” CIO discusses the Sustainability Accounting Standards Board (SASB) Standards as well as the Global Reporting Initiative (GRI) standards, which identify the subset of ESG issues most relevant to financial performance across industries, now helping to guide the disclosure of financially material sustainability information by companies to their investors. Until comprehensive standards are instituted for ESG disclosures/reporting, “greenwashing”** and conflicts of interest by companies will continue to be a major concern for regulators. To this point, in a recent 3-1 vote the SEC approved a proposed ESG rule for investment advisors and funds, which is intended to achieve more standardized and comparable disclosures and reporting of ESG information to both investors and the SEC. Additionally, the proposed amendments would establish a new ESG disclosure framework for prospectuses, annual reports and advisor brochures, incorporating both qualitative and quantitative information regarding ESG investment practices. More details can be found here.
3. New fiduciary processes: When it comes to managing a retirement plan, process is paramount. Plan fiduciaries must make prudent investment decisions and act in the best interest of the plan and its participants and beneficiaries. With the evolution outlined above, new standards, increased transparency and enhanced investment reporting capabilities will emerge to enable plan sponsors to implement ESG screening and reporting within the framework of their plan’s overall investment process, and ultimately help them fulfill their fiduciary duties.
The profound interest in ESG investing points to an increase in the prioritization of sustainability considerations, and 401(k) plan participants can play a role in that change. Today, plan sponsors can take the first step by adding ESG-specific investment strategies to their investment menus using the same fiduciary process they used to select the other plan’s investment options. In the future, plan sponsors will be well positioned to apply an ESG lens to all investments in their plans.
Talk to your plan’s advisor about your goals and objectives, so they can help you pursue them.
Main contributor:Achu Akum, Head of Retirement Plan Advisory Program Management, UBS
For more information on Retirement Plan Services, please visit our website.
*For a fund to be included in Morningstar's sustainable funds universe, it must hold itself out to be a sustainable investment, and the fund’s intent should be apparent from a simple reading of its prospectus.
**"Greenwashing" is an attempt to capitalize on the growing demand for environmentally sound products by conveying a false impression that a company or its products are environmentally sound.
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