Clients Want and Need Deeper ESG Insights

The Department of Labor moved the better part of a year ago to encourage wider use of environmental, social and governance (ESG) investing factors by retirement plan fiduciaries, both in defined contribution (DC) and defined benefit (DB) plan contexts.

Speaking to reporters at the time, Labor Secretary Thomas Perez said the new guidance essentially returns the ESG investing paradigm “back the way things worked between 1994 and 2008.” While the regulatory outlook for ESG is still somewhat complicated from the perspective of ERISA plan sponsors and advisers, the move by DOL was taken to give significantly more freedom to plan officials to implement ESG thinking without risking lawsuits.

Rather than ESG, Perez and DOL favor the term ETI, short for “economically targeted investments,” but  “we’re talking about the same thing here when we say ESG, SRI [socially responsible investing] or ETI,” Perez explained. “Whatever term you favor, ETIs are investments that are selected for the benefits they create, for example environmental or social benefits, in addition to the investment return to the employee benefit plan investor.”

New research from TIAA shows the definition and proper role of ESG/ETI is still far from universally understood among the plan participants investing in plans governed by the Employee Retirement Income Security Act (ERISA). In fact, about 40% of investors recently polled by TIAA report they are unsure if they even currently own responsible investments within their portfolios, highlighting just how low the general knowledge level around ESG investing is.

Perhaps more startling, says Amy O’Brien, managing director and head of TIAA Global Asset Management’s Responsible Investment team, is that even many advisers seem to lack deep knowledge about ESG themes.

“Even with interest in social impact growing, and the availability of more responsible investment options than ever before, greater than one in three investment advisers concede that they are not able to adequately evaluate performance of responsible investments,” TIAA warns. “These findings … expose a fundamental challenge to the investing category—the lack of understanding among investors and advisers of what responsible investing really is.”

Strictly speaking, under the DOL’s new guidance ESG investing factors can still only serve as a tiebreaker when considering economically similar investments. As Perez has clearly reiterated, “fiduciaries still may not accept lower expected returns or take on greater risks in order to secure collateral benefits.” But under the new paradigm, the DOL directly acknowledges that environmental, social, and governance factors “may have a direct relationship to the economic and financial value of an investment.” When they do, these factors are more than just tiebreakers, but rather are proper components of the fiduciary’s analysis of the economic and financial merits of competing investment choices.

NEXT: Other points of ESG confusion 

According to TIAA, many advisers are still coming to terms with this solution to the ESG Catch 22.

As the preamble to the DOL’s latest guidance states, the requirements of Sections 403 and 404 of ERISA “do not prevent plan fiduciaries from investing plan assets in ETIs if the ETI has an expected rate of return that is commensurate to rates of return of alternative investments with similar risk characteristics that are available to the plan, and if the ETI is otherwise an appropriate investment for the plan in terms of such factors as diversification and the investment policy of the plan. Some commenters have referred to this standard as the ‘all things being equal’ test.” Yet at the same time, the rulemaking “does not in any way supersede the investment duties regulatory standard of 29 CFR § 2550.404a-1, nor does it address any issues that may arise in connection with the prohibited transaction provisions of ERISA.”

Rather, Perez explained, the new rulemaking “confirms the department's longstanding view that plan fiduciaries may invest in ETIs based, in part, on their collateral benefits so long as the investment is appropriate for the plan and economically and financially equivalent with respect to the plan's investment objectives, return, risk, and other financial attributes as competing investment choices.”

Taking all this together, TIAA predicts that advisers will have more success getting clients to trust and use ESG investments only as they build up their own knowledge base about ESG pros and cons. Now is the time to learn such things, because almost three-quarters of investors say they would be “more likely to work with an adviser who could give them competitive investment returns from investments that also made a positive impact on society, and 65% of investors would be more likely to stay with an adviser who could discuss responsible investing with them.”

Meanwhile, just 45% of advisers believe this would be the case, TIAA explains, and they often choose not to address responsible investing options with their clients. “Over three in five investors (61%) indicated that their adviser had not brought up the topic of responsible investing in the past twelve months. This disconnect suggests that too many advisers forgo a chance to develop stronger relationships with their clients as a result of not communicating about these strategies.”

NEXT: Better communication and education needed 

One clearly positive sign emerging from the research is that a strong majority (75%) of advisers reported an interest in learning more about responsible investing options to better serve their clients. In addition, the TIAA research indicates a variety of valuable opportunities for advisers moving forward in doing this work, especially as it pertains to coaching clients on the interplay of ESG factors and portfolio performance.

For example, TIAA finds investors are clearly doubtful of the availability of best-in-class products in the ESG market, giving advisers an opportunity to help them find and purchase high-quality products. “In fact, more than one in four affluent investors and advisers responded that responsible investment options are very limited or that the category lacks quality choices,” TIAA finds. “Even more notably, over half (51%) of financial advisers believe responsible investing does not provide the same rate of return as other investment strategies, while 57% of investors believe responsible investing offers a lower rate of return than other strategies.”

Simply put, these broadly negative categorical statements around ESG are untrue, TIAA concludes.

“More investors are considering the balance between leveraging their assets to have a social or environmental outcome while seeking competitive performance. According to our recent socially responsible investing performance analysis, indexes that follow SRI guidelines delivered long-term performance returns comparable to the broad market benchmarks,” O’Brien explains. “Incorporating environmental, social and governance criteria in individual security selection can in fact deliver market-competitive returns.”

Thinking specifically about the ERISA domain, TIAA finds the availability of ESG investment options through workplace retirement plans “would cause 71% of affluent investors to feel good about working for their employer.” This is an even clearer effect among younger employees, with 90% of Millennial investors saying they want their investments to “deliver competitive performance while promoting positive social and environmental outcomes.”

Additional findings are presented here.