GAO Says Changes in DOL Guidance on ESG Prevent Retirement Plans from Embracing It

In a report, the Government Accountability Office (GAO) points out that whether or not retirement plans consider the projected impacts from climate change and other environmental, social and governance (ESG) risk factors could affect investment returns and, in turn, the financial health of retirees. GAO notes that some investors believe that companies with good corporate governance practices are better managed and will perform better financially over time.

GAO says that examples of environmental factors are climate change impacts, energy efficiency and waste management. Social issues include labor standards, human rights, and gender and diversity. Governance includes board composition, executive compensation, whistleblower programs, and accident and safety management.

Citing a report from US SIF: The Forum for Sustainable and Responsible Investment, investors in the United States are increasingly incorporating ESG factors into their investment management. According to US SIF, assets in the U.S. that considered ESG factors in 2016 were $4.7 trillion, a 14% increase from 2014, when they were $4.1 trillion. Globally, the amount of assets using ESG factors was $22.9 trillion in 2016, up 26% from $18.3 trillion in 2014.

However, few retirement plans in the United States incorporate ESG factors into how they manage investments, GAO says. Asset managers told GAO that retirement plans face several challenges, including a lack of consistent and comparable data on ESG factors and regulatory uncertainly.  According to the Plan Sponsor Council of America’s (PSCA) 2016 survey of 600 defined contribution (DC) plans, only 2% offered an ESG investment option to participants. The asset managers told GAO that if companies were required to standardize reporting of ESG factors, that would help retirement plan sponsors to be able to assess funds that use ESG factors.

GAO also notes that while finding incorporating ESG factors has a positive or neutral impact on financial performance, the perception that it could negatively impact performance persists, and this is another impediment to retirement plans incorporating ESG investing. Yet another problem the asset managers told GAO about is that incorporating ESG factors in investment management may increase costs to retirement plans because of the additional resources needed to assess the ESG factors.

Several asset managers told GAO that incorporating ESG in retirement plans could increase the complexity of plans for participants, and plans have been, instead, looking to reduce the number of funds in their lineup.

And perhaps most notably, asset managers also said that the Department of Labor’s (DOL’s) guidance on ESG investing has changed with different administrations, making retirement plans very wary of relying on that guidance. Additionally, in April, the DOL issued a Field Assistance Bulletin on ESG investing that—given some of the strong language used to warn retirement plan fiduciaries against placing other interests ahead of the financial benefit of their participants—has created some confusion.

The few asset managers with retirement plan clients using ESG said the plans are not using them as the qualified default investment option (QDIA) but as an option in the fund lineup. Asked what benefits incorporating ESG factors into investment management brings to retirement plans, the asset managers said it enhances risk management, improves long-term performance and increased participation.

GAO notes that while the DOL has said that retirement plans may incorporate ESG factors in investment analysis, the DOL has not addressed whether plans can incorporate ESG in the plan’s default option or qualify for legal protections. GAO says that in other cases where plans may face complexity, such as selecting a target-date fund or monitoring pension consultants, the DOL has provided general information, including items to consider and questions to ask. GAO suggests that the DOL do the same with ESG investing.

GAO’s full report can be downloaded here.