The Markets October 20, 2022

ESG Adoption Slow Among DC Plans

One factor hindering ESG’s adoption is the lack of ESG-focused target-date funds, though several firms are starting to introduce them. 

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Plan participants claim to want environmental, social and governance investment options in their defined contribution plan lineups. The Schroders 2022 U.S. Retirement Survey found that 87% of DC plan participants surveyed want their investments to be aligned with their personal values. It’s not just empty talk, according to the survey: Interested participants follow through with investments: “Of the 31% of 401(k) plan participants surveyed who knew their plan offered ESG options, nine out of ten invested in those options, and almost three-quarters (73%) estimate they allocate 50% or more of their assets to socially responsible choices.”

The growth in the number of ESG funds and their assets supports the case for strong investor interest. Morningstar’s “Sustainable Funds U.S. Landscape Report” for 2021 found that sustainable funds attracted a “record $69.2 billion in net flows in 2021, a 35% increase over the previous record set in 2020. … Assets in sustainable funds landed at a record $357 billion at the end of 2021, more than 4 times the total three years ago.” Morningstar also reports that the number of sustainable open-end and exchange-traded funds available to U.S. investors increased to 534 in 2021, up 36% from 2020.

Nonetheless, participants’ interest and the segment’s growth aren’t reflected in many retirement plans, and the availability of ESG options varies widely among plan types. Callan Institute’s 2021 ESG Survey contacted 114 U.S. institutional investors and found that 63% of public plans offered ESG options. Foundations (57%) and endowments (50%) followed closely, but only 20% of DC plans offered a dedicated ESG option. Vanguard’s recent “How America Saves” study found just 13% of the company’s DC plan clients offered socially responsible funds in 2021. Similarly, a Russell Investments survey from earlier this year of 28 of its U.S.-based defined benefit and DC clients found that only two of the plans offered an ESG investment option.

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Unlike Schroders, Callan and Vanguard both reported participants’ use of the available ESG options in their plans was low. The Callan DC Survey reported a 1.2% participant average allocation of account balances to a plan’s dedicated ESG option. Vanguard found that just 6% of participants were using the available socially responsible funds.

Reasons for Slow Adoption

Most of the ESG implementation so far has occurred in plans at organizations whose purpose naturally aligns with ESG factors, says Jessica Sclafani, senior DC strategist for the Americas division with T. Rowe Price in Baltimore. “Think health care or religious organizations for the most part,” she says. Technology companies also tend to be more interested, she says, adding geographically, the interest has been concentrated in the Northeast and on the West Coast. “However, we are seeing many sponsors who continue to describe themselves as ‘sitting on the sidelines’ until we get a final ESG rule from the Department of Labor,” says Sclafani. She anticipates a final rule will be promulgated around the end of this year. “Until then, I think that we will continue to see education and interest in exploring ESG, but implementation is likely to stay on hold,” she adds.

Thomas Shingler, a senior vice president and Callan’s ESG practice leader in Summit, New Jersey, also points to regulatory-induced hesitation among sponsors. He notes that terms like “whiplash” or “ping-pong” are used to describe changes in DOL guidance and rulemaking under successive Republican and Democratic presidential administrations. The switches have made it difficult for plan fiduciaries, advisers and consultants like Callan to navigate ESG-related decisions, he says. Shingler anticipates that the DOL will issue its final rule this December; consequently, he expects more ESG adoption in 2023 and 2024.

Lack of Targets

Another factor hindering ESG’s adoption is the lack of ESG-focused target-date funds. TDFs, fueled by automatic plan enrollment and their status as many plans’ qualified default investment alternative, capture a large share of participants’ investments. According to Vanguard, by year-end 2021, 64% of all Vanguard participants were solely invested in an automatic investment program and 56% of all participants were invested in a single TDF.

The dominance of TDFs creates a problem for ESG funds looking to get into DC plan lineups. Greg Wait, partner with ESG advisory firm Riverwater Partners in Milwaukee, says there is only one ESG target-date series available with a five-year performance record—the Natixis Sustainable Future Funds. “There’s almost nothing to choose from for a plan sponsor to add an ESG target-date fund when there’s only one on the marketplace,” says Wait. “And I think the fact that there’s only one in the marketplace also makes some plan committees and fiduciaries nervous, because while they can compare it to other target-date funds, they can’t compare it to other ESG target-date funds.”

Several companies are developing ESG TDFs. BlackRock launched its LifePath ESG Index series in 2020 and in May, Putnam Investments announced it will reposition its Putnam RetirementReady Funds target-date series as the Putnam Sustainable Retirement Funds. In October 2021, Morningstar announced that it was working with Plan Administrators Inc. to launch a pooled employer plan “intentionally designed to limit exposure to material environmental, social and governance risks.” Morningstar Investment Management will also create a custom ESG TDF portfolio for the PEP that is specifically designed as a QDIA option. In March, Transamerica, Future Plan by Ascensus and Natixis Investment Managers announced joint plans to introduce an ESG TDF series.

Zach Stein, co-founder of climate-focused robo-adviser Carbon Collective in Albany, California, also sees a shortage of ESG TDFs in the market. He says that some of his firm’s clients opt to use the firm’s climate-focused target-date portfolios as their QDIA, but these are balanced portfolios—rather than funds—that follow the firm’s investment strategy. “We have not been able to find an ESG or sustainability-focused retirement (target) date fund we feel comfortable ethically recommending to our clients,” he explained by email. “The closest is from Natixis, but they are quite expensive and hold companies like Exxon that don’t make sense to us in a sustainably-focused portfolio.” 

TDF Alternatives

Another approach to getting ESG funds into a plan lineup that Wait has used with clients involves the creation of three “tracks” for the DC plan. One track is a standard target-date fund. The second track includes multiple funds with different investment objectives, such as U.S. large cap, U.S. small cap, international equity and a fixed-income option. The third track mirrors the multifund second track but uses ESG funds. “I think it’s a really prudent approach because then you’re offering your participants a choice of having ESG funds in the same manner as you’ve got non-ESG funds,” Wait says. “You’re allowing those participants, if they choose, to build for themselves a fully diversified account of ESG funds.”

Brokerage windows are another option. Alan Hess, associate vice president for U.S. Fund Research at ISS Market Intelligence in Boston, says brokerage windows fit with how ESG funds are sold within the broader market. “The ability to incorporate ESG factors within strategies that can normally appear on investment lineups means that pursuing them through a brokerage window is a less high-risk strategy on the part of an interested investor,” says Hess. “Plan sponsors still weighing regulatory uncertainty from shifting administrations may find an incentive to point investors more toward these windows than revamping their current lineups.”

ESG investing is likely more widespread among DC plans’ investments than recognized, however. Kerry Galvin, a New York City-based senior consultant with Russell Investments, says the lack of a distinct ESG option or investment manager doesn’t mean that a plan’s lineup isn’t using ESG in some format. Managers are “using E, S and G factors in their underlying stock analysis to better inform their stock-selection decisions,” Galvin says. “I think that’s an important distinction to make. That is what our corporate plan sponsors are offering, but that’s also what’s going on with the managers they’re utilizing.”

In a May blog post, Galvin noted that Russell Investments’ 2021 Annual ESG Manager Survey found that “82% of U.S.-based investment managers reported using explicit ESG factor assessments in their investment decisions. Governance remains the ESG factor which impacts investment decisions the most. However, the usage of environmental factors is increasing.”

Compliance October 20, 2022

Elevator Constructors’ Union Retirement Plan Sued

Two counts for breach of fiduciary duty were brought against the defendants.

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Retirement plan participants have brought a class action lawsuit against the International Union of Elevator Constructors and the multiemployer 401(k) retirement plan on behalf of members of the elevator constructors union. The suit alleges excessive fees for plan services.

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The named defendants to the lawsuit include the executive board of the union, the board of trustees of the Elevator Constructors Annuity and 401(k) Retirement plan, and 30 unnamed individuals.

“The plan was saddled by outrageous per participant fees,” the complaint states.

The plaintiff’s complaint asserts two counts against the international union and board defendants—alleging  fiduciary breach of prudence to participants, against the committee and failure to monitor other fiduciaries to the plan.

“Defendants did not adhere to fiduciary best practices to control plan costs … such as monitoring investment management fees for the plan’s investments, resulting in several funds during the class period being more expensive than comparable funds found in similarly sized plans—conservatively, plans having over [$]in assets,” the complaint states. “Had a prudent process been used, the plan would not have been saddled with a total plan cost that was more than 160% higher than the median for similar plans.”

The plan had at least $2.6 billion in assets under management during the class period, the court filing shows and over 29,000 participants as of 2020. The plan’s asset amount qualifies it as a jumbo plan in the defined contribution plan marketplace, and among the largest plans in the United States, according to the plaintiff’s complaint.

Attorneys for the plaintiffs have alleged that the plan’s recordkeeper, Mass Mutual, charged between $95 and $125 per participant—from 2016 to 2020—for recordkeeping and administration services.  

The complaint argues, as a ‘jumbo’ plan, fiduciaries for the union plan should have been able to negotiate lower recordkeeping costs, ranging from $14 to $30 per participant.

“Anything above that would be an outlier especially later in the class period when [recordkeeping and administrative] costs per participant should have been at the cheapest,” the complaint states.

Plaintiffs’ have alleged against fiduciaries near identical excessive fee claims for the plan’s investment management fees and the 401(k) target-date fund that was used as the plan’s qualified default investment alternative, in the complaint.  

From 2016 to 2019, the plan’s target-date suite was the T. Rowe Price Advisor Class series, that carried expense ratios from 92 basis points to 97 basis points for the 2060 fund, the court filing shows. In 2019, the plan moved to the T. Rowe Price Investor Class Series that had expense ratios ranging from 53bps for the 2030 fund to 59bps for the 2060 fund.

“The Investor class was a choice which was still not the best choice for the plan,” the complaint states.

Plaintiffs allege plan fiduciaries move to the less expensive suite “was too little too late as to the damages to the plan had already been baked in,” and further, management failed to use remaining, less costly options for plan participants, according to the complaint. 

“[T]he plan could certainly have qualified for the [collective investment trust] version of this target-date fund,” the complaint states. “The CIT version is nearly identical to its mutual fund version in all material respects having the same fund managers and same underlying investments.”

The complaint shows that a version of the CIT carried a 46bps fee for all target-date years from 2020 to 2060.

“Had either the CIT version of this target-date suite or the Investor Class version been selected from the inception of the class period, the plan would have realized greater savings, which would have compounded over the years,” plaintiffs allege.

Citing Supreme Court precedent from the ruling in the 2022 decision Hughes v. Northwestern Univ., the plaintiffs asserted plan fiduciaries have a continuing duty to monitor investments and remove underperformers.

While the complaint is typical of excessive fee claims, it is uncommon for such lawsuits to target a multiemployer plans’ defined contribution plan.

The complaint erroneously termed the Taft-Hartley union plan “a multiple employer plan.” The plan is, in fact, a multiemployer plan for union members.

Plaintiff’s attorneys, from Harrisburg, Penn.-based law firm Capozzi Adler, filed the complaint in the U.S. District Court for the Eastern District of Pennsylvania. The attorneys argued for the court to certify the class period as any time between October 13, 2016, through the date of judgment.

The Elevator Constructors Annuity and 401(k) Plan was a 2019 finalist for Plan Sponsor of the Year. 

The International Union of Elevator Constructors is headquartered nationally in Washington, D.C. The principal place of business is in Newton Square, Penn.

Requests for comment to the union on the lawsuit were not returned. 

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