ESG Investing Hits Hurdles in DC Plan Market

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A failure to communicate may be one description of how defined contribution plan sponsors and plan participants view environmental, social and governance-focused investments. Yet the problems with using these products for plan sponsors go deeper, according to a new study by Cerulli Associates.

Cerulli’s 2018 study of 1,000 401(k) participants found 56% preferred ESG investing. That figure varied across age groups; 63% of participants 39 and under preferred ESG investing, on the high end, while only 37% preferred it between ages 60 and 69, on the low end.

Further, 62% of women prefer ESG investing versus roughly half of men, the study found.

However, plan sponsors have a different view. In a Cerulli study of 800 401(k) plan sponsors, 46% of respondents felt ESG factors for investing were “very important.” But, as the report notes, “plan sponsor perspectives on ESG factors differ when contextualized with other investment attitudes.” When plan sponsors were asked to name the top three most important attributes when selecting plan investments, ESG ranked last of the eight reasons with 16% of responses. The top responses were long-term performance (45%) and cost of investments (38%).

Another problem in the DC market was the lack of ESG options. According to to research from Callan, only 16% of DC plans offered “dedicated ESG options.” And of those who do, usage is low; only 2% of assets in those plans were allocated to ESG options, the Callan report noted. Cerulli stated the usage might be even lower because Callan “skews toward large and mega plans.”

In sum, the Cerulli report stated that “fee sensitivity and the notion that ESG investing entails a trade-off in performance are two broadly applicable headwinds to ESG adoption.”

Regulatory Hurdles

Another issue, specific to the DC plan market, is regulatory obstacles in using ESG products. In 2015 and 2016, the Labor Department issued field assistance bulletins that basically stated that “fiduciaries may use ESG factors as a ‘tie-breaker’ when choosing between two investment options that are otherwise equal with respect to return and risk.”

This was turned on its head when the department issued in 2018 a bulletin that stated “nothing in the [qualified default investment alternative] regulation suggests that fiduciaries should choose QDIAs based on collateral public policy goals.” As Cerulli noted, “ESG investments must be prudent options for all plan participants, not a select group or sub-segment. … DOL guidance and idiosyncratic nature of ESG investing create significant hurdles.”

(Related: New DOL Bulletin Muddies ESG Waters)

Another problem with sustainable investing, asset managers stated, was the “challenge of effectively benchmarking ESG funds.” Different funds prioritize different ESG factors — the environment, for example — resulting in funds that are “materially different,” the report noted.

Bottom line: Despite the huge growth in the ESG marketplace — a recent Morgan Stanley/Bloomberg survey found roughly $12 trillion is invested based on sustainability principles — Cerulli found that education is essential not only in the DC plan market but the asset management industry to spur greater adoption of ESG investing.

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