Advisers Play Important Role in Bringing ESG to ERISA Plan Clients

The Department of Labor issued a Field Assistance Bulletin in 2018 that caused some confusion about its true stance with respect to ESG investing inside ERISA plans; investment experts and attorneys say interest remains strong among plan sponsors and participants, nonetheless.

Art by Dalbert B. Vilarino


On April 23, 2018, the U.S. Department of Labor (DOL) published a Field Assistance Bulletin providing guidance to fiduciaries of private-sector employee benefit plans as they consider implementing environmental, social and governance (ESG) investing for assets covered by the Employee Retirement Income Security Act (ERISA).

According to the DOL, the “sub-regulatory action” was not meant to substantially change the status quo with respect to ESG investing under ERISA, but instead merely to clarify how the new administration views existing regulations in this area. In particular, the Field Assistance Bulletin addressed Obama-era DOL 2015 guidance on economically targeted investments and related 2016 DOL guidance on shareholder engagement.

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Even though the DOL was careful to note that it had not changed the underlying regulations with its bulletin, retirement industry stakeholders were left to reassess their own stances on the risks and rewards of utilizing ESG investments for plan assets. According to attorneys with Stradley Ronon, this period of introspection has largely concluded, and ESG “continues to proliferate at breakneck speed across asset classes.”

In written commentary shared with PLANADVISER, Stradley Ronon attorneys said they are helping both registered and private-fund clients incorporate various ESG strategies. They are also advising fiduciaries on the implications of using ESG under ERISA, “such as how integration, shareholder engagement and divestment can be conducted in a manner consistent with ERISA.”

“We simply don’t see ESG going away anytime soon,” they explained. “Environmental, social and/or governance issues are a fact of life. Cybersecurity and climate change are two examples.”

According to the attorneys, one factor slowing growth in this domain is widespread confusion over what ESG actually means. In particular, clients want to know how “ESG investing” differs from “impact investing,” “socially responsible investing,” “economically targeted investing,” and “sustainable investing.” They also spend a lot of time explaining that the days are gone when ESG investing consisted primarily of either screening out or divesting from certain issuers/sectors because they do not meet some moral or other noneconomic test.

“Today’s ESG is much more driven by data linking one or more ESG factors and investment performance—an ESG factor can now be a material risk,” the attorneys wrote. “On an even more fundamental level, there is not unanimity on what constitutes an E, S or G factor. ESG is an umbrella term capturing as many as 40 different topics.”

George Michael Gerstein, co-chair of the fiduciary governance practice at Stradley Ronon, suggested the DOL “might prefer integration as an ESG approach over strategies that make investment decisions for moral reasons or to otherwise promote a public policy.”

Gerstein defined “ESG integration” as more sophisticated efforts by managers to incorporate ESG-related data or information into the wider process they use when making an investment decision within a given fund or portfolio. The main purpose of such integration is to enhance portfolio return or reduce portfolio risk, rather than to advance an environmental or social cause.

“The DOL stresses the importance of documenting why the fiduciary believes the respective ESG factor will have a material effect on performance, without having to make a series of wishful assumptions to reach that conclusion,” Gerstein said. “We suggest that fiduciaries will want to build a record in support of the view that a particular factor bears a relationship with investment performance, and carefully consider how much weight to put on that specific factor.”

The Stradley Ronon attorneys pointed out that the DOL’s most recent guidance on the ESG topic also “zeroed-in on shareholder engagement in respect of ESG issues that have a connection to the value of the plan’s investment in the company, where the plan may be paying significant expenses for the engagement or development of proxy resolutions.”

If anything, the attorneys concluded, this shareholder engagement aspect of the most recent DOL bulletin has the most significant ramifications—though it has received less attention from sponsors and advisers.

“If plans are viewed as paying indirectly for engagement through the management fee, which view we think the DOL takes, then proxy voting and other forms of shareholder engagement need to be monitored for both costs and benefits, particularly as the time spent on the engagement increases,” the attorneys recommended. “In our view, ESG will continue to evolve and proliferate, while also garnering the attention of both the DOL and SEC on a number of levels. ESG is, in essence, entirely fluid and will continue to present business opportunities and compliance challenges. We will likely have more to say on this in the coming weeks.”

Hands-Off Approach Likely from SEC?

Despite calls for additional guidance to ease fiduciary concerns, regulatory experts do not broadly anticipate further action under the current administration.

The Trump DOL, indeed, has already “clarified” its stance on ESG investing under ERISA. And when it comes to the prospect of the Securities and Exchange Commission (SEC) building some sort of unified ESG reporting framework for stock issuers, that’s also seen as unlikely.

In fact, in one of his final public speeches of 2018, SEC Chair Jay Clayton directly addressed this topic. From his perspective, Clayton said, the main hurdle to a wider embrace of ESG or SRI investing by fiduciaries has to do with the availability, quality and comparability of data being provided by publicly traded companies. Yet he does not necessarily see this as a challenge for SEC to address.

“Disclosure is at the heart of our country’s and the SEC’s approach to both capital formation and secondary liquidity,” he said. “As stewards of this powerful, far-reaching, dynamic and ever-evolving system, a key responsibility of the SEC is to ensure that the mix of information companies provide to investors facilitates well-informed decision making. The concepts of materiality, comparability, flexibility, efficiency and responsibility (i.e., liability) are the linchpins of our approach.”

Turning to ESG, which he called “a broad term,” Clayton said the investment industry is increasingly seeing disclosure of ESG information by issuers—and requests for ESG information by investors.

“I am also aware of efforts by third parties to develop disclosure frameworks relating to ESG topics as well as calls by some market participants for issuers to follow third-party disclosure frameworks relating to ESG topics,” he said.

Clayton said his belief is that while third-party standards relating to ESG topics may allow for comparability across companies, this should not mean that issuers should be required to follow these frameworks in order to comply with SEC rules.

“Each company, and each sector, has its own circumstances, which may or may not fit within a standard framework,” Clayton said. “That does not mean the standards do not have value. They do, in some cases, in much the same way that appropriately presented non-GAAP financial measures and key performance indicators add value to the mix of information.”

Clayton went on to say that as third-party standards have evolved and been discussed by market participants, he has seen investor-company dialogue around “certain issues and in certain sectors improve.”

“That said, I think it is important to remember two principles: first, in complying with our disclosure rules, companies should focus on providing material disclosure that a reasonable investor needs to make informed investment and voting decisions based on each company’s particular facts and circumstances; and second, investors—and here I’m thinking about asset managers who are required to vote in the best interest of their clients—should also focus on each company’s particular facts and circumstances,” Clayton said.

“It is important to note that although we do regulate disclosure and oversee registered investment advisers, we do not regulate the merits of any particular investment strategy,” he concluded. “The success of a particular investment strategy depends upon a multitude of factors, which may or may not include the extent to which the asset manager incorporates ESG factors. From my perspective, what is important is that investors have full and fair disclosure of the material facts about the investment strategy their fiduciary is following so that they are in a position to make informed investment choices.”

Will Emerging Advisers Help Drive Demand?

Social impact and ESG investing is growing in importance among the new generation of financial advisers in the U.S., according to a recent Incapital survey.

The survey looked at advisers with between three and nine years of industry experience, finding that very nearly all (99%) of those who use individual bonds discuss social impact goals with their clients. This is almost 25% more than advisers with over 10 years of tenure, according to the survey.

“This generation has had more access to information on social impact investing than any before them, so it is no surprise that Millennials and the generation of advisers that serve them are like-minded in their support of results-driven causes,” observed Louise Herrle, managing director and head of Incapital’s platform for distributing social impact investments. “They understand that they can achieve their clients’ financial goals with investments that reflect their personal values.”

A majority of surveyed advisers continued to use equity assets to achieve social impact or ESG goals, with fewer using fixed-income options. On the equity side, 44% of advisers said they use actively managed equity mutual funds for ESG/SRI exposures, 35% use individual stocks, and 31% use equity exchange-traded funds. At the same time, 30% use fixed-income actively managed mutual funds, 29% use bonds, and 22% use fixed-income exchange-traded funds.

More than half (58%) of those advisers with three to nine years of tenure agreed there are too many equity ESG options and not enough fixed-income ESG options to show their more conservative investors. Only 34% of advisers with over 10 years of tenure agreed, however.

“Advisers are looking for options that best match their clients’ risk tolerance,” Herrle said. “Equity ESG funds may have too much risk for some conservative clients. Advisers are finding that social impact bonds—which do carry credit risk but also the benefits of income predictability, return of principal at maturity and declining interest rate risk as the maturity date approaches—can be utilized as part of a conservative income portfolio strategy.”

This Plan Sponsor Is All-In on ESG TDFs

Many plan sponsors fear being a trendsetter, but United World College-USA is proud of using ESG investing themes in its custom target-date QDIA, built with TIAA and LongView Asset Management, and offering a guaranteed retirement income solution.
Art by Andrea D'Aquino

Art by Andrea D’Aquino


Very quickly in a conversation with Victoria Mora, Ph.D., president of United World College (UWC)-USA, one gets the sense that she has a clear passion for her work and her employees—as well as a belief that UWC-USA is a values-driven educational organization, which defines its raison d’être as more than to financially succeed.  

Similar to other trendsetting retirement plan sponsors, the employer’s enthusiasm for institutional excellence bleeds directly into the domain of employee benefits and financial wellness. As a result, United World College-USA has become one of the first plan sponsors to embrace environmental, social and governance (ESG) investing principles within its defined contribution (DC) retirement plan’s default investment option. And if that weren’t innovative enough, the plan’s automatic features also include a guaranteed retirement income component, made possible via TIAA’s custom model portfolio services, and glide path consulting from LongView Asset Management.

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“Our core belief as an institution is that education is an incredible force that can work beyond itself to create broad social change and improvement,” Mora told PLANADVISER. “Education can often be seen or talked about as a personal accomplishment, but we know that the value of a good education goes far beyond the individual person to impact the whole community. Education is a force for change for the better, for global peace and a sustainable future.”

According to Mora, UWC-USA makes all of its decisions and policies with its broader mission in mind. This includes decisions and policies to do with employee compensation and retirement benefits.

“People already know that, throughout the education space, hardworking educators are often not valued or compensated at the level [many] think they deserve, given the crucial role they play as the conveyors of knowledge from the older generation to the next,” Mora said. “In the last few years, we started to talk a lot about what it really means to live your mission and live your values, especially where the rubber hits the road with financial matters.”

So, as the ESG topic has gained momentum, Mora and UWC-USA saw “a wonderful opportunity to align what we’re doing for employees’ retirements with what we are helping our students to learn every day.” In basic terms, the default investment product UWC-USA offers to retirement plan participants is a custom target-date solution that weighs ESG factors directly as part of its asset-allocation process and includes an automatic in-plan retirement income component for educators that reach and enter retirement.

How a Custom ESG TDF Came Together

Mora credits TIAA and LongView Asset Management for helping her and her colleagues—in particular, the plan’s fiduciaries and finance staffers—see the opportunity that ESG investing presents.

Douglas Lynam, director of educator retirement services at LongView Asset Management, credits Mora and her colleagues for being willing to try something new. In fact, he and Mora have a strong rapport that has inspired stakeholders to embrace an innovative strategy for the plan’s default investment scheme.

“When we were looking at this plan as a potential client, we saw a big opportunity to help UWC-USA understand its fiduciary duty and how it could implement its mission while also improving retirement outcomes for employees,” Lynam said. “We naturally had a lot of discussions about the Department of Labor [DOL]’s fiduciary duty requirements under ERISA [Employee Retirement Income Security Act] and what the law says and doesn’t say about the use of ESG investing programs.”

Using language adopted by a growing number of institutional asset managers that have enthusiastically embraced ESG, Lynam said LongView “knows that ESG-thinking is a benefit to performance, lowering risk as it helps to improve diversification.”

“Sustainability and environmental issues are absolutely material to long-term investment decisions being made today, and those include decisions about the qualified default investment alternative [QDIA] in retirement plans,” Lynam said. “The data and research is clear that ESG can give you a performance edge, when implemented effectively.”

As to why the custom model portfolio approach was best in this case, Lynam suggested there are “still only a pretty limited number of options out there now for an off-the-shelf ESG TDF [target-date fund].”

“Especially when it comes to the price of the prepackaged options, we felt that was more expensive than what we would normally recommend as a default investment,” Lynam said. “When we looked closely at the TIAA model portfolio approach, the light went on. We realized we could create a custom portfolio that incorporated ESG and retirement income at the same time, while, from the user perspective, appearing to be essentially a low-cost TDF.”

There are other recordkeepers that can do this, of course, but Lyman said TIAA was “very helpful in creating this solution.”

“We are proud to be partnering with them on this solution, especially because the cost we achieve with this model is less than half of what you might pay for a prepackaged ESG target-date fund,” Lynam said. “The price is down to 27 basis points [bps], which we feel is pretty spectacular for the value the client is getting, especially considering this is a $1.8 million plan. It’s a small plan sponsor taking the lead here.”

The Recordkeeper’s Perspective

In a separate interview, Mark Foley, managing director for institutional financial services at TIAA, commended the work done by LongView and UWC-USA, calling their custom ESG solution a clear trendsetter.

“Clients come to us wanting to directly address lifetime income a lot more, these days, but the industry is only now reaching the point where we can operationalize this type of solution,” he said. “When we can get lifetime income solutions linked up with the default options in a plan, we think that can be a really powerful combination for improving participant outcomes and confidence about retirement.”

Foley said other clients have taken their own innovative approaches using this type of adviser-supported custom model portfolio arrangement as the default retirement plan investment.

“Some clients make ESG the focus of their custom solution, while others take other approaches,” Foley observed. “Each institution now has the ability to design its own structure and allocations—and not just the mega-sized investors. As the recordkeeper, we are striving to offer a very flexible platform, which will allow our asset management partners and our plan sponsors to take a variety of approaches.

“From the outset,” he continued, “we could see that ESG was really important to UWC-USA and its adviser. They believe that ESG brings the best combination of risk and return, and we are happy to operationalize that for them.”

Mora emphasized that this was a long-term effort to get an ESG-focused custom default investment up and running.

“Working with Doug and TIAA, we really had some eye-opening conversations about the potential alignment between financial decisions and the alignment of values and principles,” she said. “There was this moment where it really crystalized. Doug helped us see that ESG is absolutely material right now by asking, what does it mean to invest in an individual’s future while ignoring the future of the whole society or the planet? It’s a hard thing to un-think. At UWC, our employees believe in education as a force for good, so it was not very difficult to generate conviction around this new approach.”

Asked if she was nervous about being a trendsetter and trying something new in a space with strict regulations and an all-too-eager plaintiff’s bar, Mora said, “It’s always a bit scary to be out front. But, when you feel like you’re doing something that is right, then you set your fear aside and do it. A significant part of the work in the first year was demonstrating to all of our stakeholders that it’s a good thing to be a trendsetter.”

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