In
a significant number of American households, defined contribution (DC)
retirement plan participants’ investment allocations occupy the extremes, finds
an analysis from Towers Watson.
About
15% of investors shy away from equities entirely, while roughly 22% invest
everything in equities. In “Asset Allocations: How American Workers Are
Investing Their Retirement Savings,” Tusheng Huang and Gaobo Pang note that avoiding
equity entirely forgoes opportunities for higher returns, and investing
everything in equities poses the risk of major losses.
However,
according to the analysis, the extent of extreme investing declined from 2004
to 2013, suggesting that households are better diversifying their retirement
portfolios. Qualified default investment alternatives (QDIAs) presumably have
attracted more workers into the equity market, the authors say.
The
analysis shows equity exposure declines as workers age. Equity market
participation (non-zero in equity) is highest among investors in their 30s
through 50s. Roughly 37% of 25- to 34-year-old investors hold 75% or more of
their savings in equities, compared with about 26% of 65- to 74-year-olds. This
link between risk reduction and age is basically consistent with life-cycle
financial advice, the report notes.
In
addition, target-date funds (TDFs), which have become an increasingly popular DC
plan QDIA in recent years, start out with greater equity holdings and then
automatically reduce equity allocations as participants near retirement. Among
age 55 to 64 households, the median equity allocation was around 50% from 2004
through 2013. This falls in the middle of the TDF glide paths established by major
fund providers, the report says.
According
to the analysis, the equity share of DC accounts is generally larger when
participants are aware of investment options and are able to choose their own
investments. Nearly 33% of households with no control over their investment
selections have no equity investments. Plans that do not allow participants to
choose their investments may be more likely to maintain conservative asset
portfolios, the report says.
This analysis
examines the salient patterns of workers’ asset allocations in retirement
accounts using the Survey of Consumer Finances (SCF, 2004, 2007, 2010 and 2013
waves). It combines all DC-type accounts from current and prior jobs for each
household and calculates the value-weighted percentage invested in equity.
Individual retirement accounts (IRAs) are disregarded. The report is here.
By using this site you agree to our network wide Privacy Policy.
Department of Labor advisory opinions make it challenging to
include environmental, social or governance (ESG) investing themes in a tax-advantaged
retirement plan, but some investment managers want to change that, and the
reasons they cite probably differ from what industry practitioners expect.
Part and parcel of a plan sponsor’s basic fiduciary duty is
to hold the economic interests of plan participants above all other factors when
making investment decisions. This holds across the defined benefit (DB) and
defined contribution (DC) plan paradigms, explains Bradford Campbell, counsel
with Drinker Biddle & Reath LLP and former head of the Employee Benefits
Security Administration (EBSA) at the Department of Labor.
Regardless of who holds final discretion over where
participant dollars are directed, plans are faced with very little flexibility
in this area, he says, and must subvert ESG factors to economic factors. Such a
rigid outlook is causing some to ask whether the DOL should take action to
allow more ESG-type thinking in the qualified plan context—especially as niche investment
managers emerge with claims that all investors can benefit economically from
using more ESG thinking.
Before looking ahead to the future of ESG and qualified
retirement plans, it will be helpful to review how ESG factors are treated by
the Department of Labor (DOL) and its most important instrument for protecting retirement
plan participants: the Employee Retirement Income Security Act (ERISA).
The DOL’s latest advisory opinion directly touching on
social and/or environmental investing came down while Campbell was helping to
run the EBSA under President Bush, between 2007 and 2009. Campbell explains the
DOL’s current guiding interpretative bulletin on ESG investing within qualified
retirement plans is known as “29 CFR 2509.08-1.”
The 2008 guidance
clarifies when non-economic factors can be
considered by investment fiduciaries serving tax-qualified retirement
plans. In
a nutshell, the DOL concluded that they are a reasonable tiebreaker,
Campbell tells
PLANSPONSOR. This means that only in cases where a sponsor has done a
full
economic analysis and has discovered two investments are essentially
equivalent in terms of the role each would play for plan participants
can that sponsor base investing decisions directly on ESG
factors.
“When you have an economic tie and then you need to have
some way to make a determination, only at that point does it become appropriate
to consider issues beyond the pure economics of the investment,” Campbell says.
This framework doesn’t leave much room, if any, for sponsor’s
to actually bring ESG into their plan, even in the DC context, where it is
conceivable a plan participant would actively choose an ESG investment
specifically for its environmental, social or governance characteristics. The chances
a sponsor will have the time (or interest or resources) to run this kind of
analysis, and then have enough confidence in the analysis to base a documented fiduciary decision on it, are pretty slim.
A sister bulletin also issued during Campbell’s tenure, filed
as “Bulletin 08-02,” deals with questions concerning when it is appropriate for
retirement plan participants and sponsors to operate as “shareholder
activists”—using plan assets to influence the way companies or industries are
managed. These questions get into a similar analysis, Campbell says.
“It’s very simple really,” he concludes. “As things stand
today, in order to spend money to try to change the way companies are operating
or to address environmental factors, the fiduciary needs to be sure this will
have a clear economic benefit for the plan.”
Looking Ahead
Responsibly
With so many difficult regulatory issues confronting employer-sponsored
retirement plans, David Richardson, managing director and head of institutional
business development at ESG specialist Impax Asset Management, says he is not
surprised that few plan sponsors and service providers have stood up to
challenge the DOL’s unfavorable view of environmentally minded investing in
retirement plans.
He explains
that Impax was first launched in 1998, “to help endowments and other large
asset holders structure their portfolios to capture opportunities in addressing
issues like climate change and resource scarcity, as these investment themes become more important to overall portfolios.”
“We were
around during the creation of what I like to call ESG 1.0, which was really
just a way to screen defense-related investments or other ‘sin stocks’ out of clients’ portfolios,” Richardson explains. “Since then, we have watched
as this thinking has become much more sophisticated. I would say we have, as an
industry, evolved well beyond ESG 2.0 and are pushing into the territory of ESG
3.0.”
He explains ESG 2.0 as the movement that followed up sin-stock screening. As large institutional investors started to think more deeply about environmental, social and governance risks, they started asking what other categories of companies or investments could or should be screened out from portfolios, and in what ways.
“We have seen
screens develop in response to water scarcity concerns or carbon emissions, as
a few examples,” Richardson notes. “As part of this evolution, there has been a
steadily expanding cadre of asset managers who subscribe to the belief that ESG
factors are not just moral issues. They include critical factors that speak to
the overall risk-return outlook of any portfolio.”
Richardson says this thinking is leading to a new approach
and mindset around ESG—one that is not based on negative screening of stocks
but on the positive attributes ESG thinking can bring to a portfolio from a
purely economic perspective. This positivity is the hallmark of ESG 3.0, he
says.
“Today we are at a point where we are ready to apply
powerful technology and ESG principals together to cut portfolio risk and boost
returns in an economically meaningful way,” Richardson says. “One aspect of
this thinking is just the recognition that, regardless of your view on climate change, making investments in companies that are doing better than their
peers on energy efficiency, use of renewable energy, resource recovery, waste mitigation
and water efficiency offers the prospect of superior portfolio growth.”
Richardson says the important element to ESG 3.0 for plan
sponsors and other fiduciaries to consider—the reason why the conversation is
becoming more and more relevant even under the restrictive DOL guidance—is this
positivity.
“We’re no longer talking about limiting a portfolio’s
return
outlook because we don’t want to put money into certain categories of
stocks
that happen to have negative social or environmental associations,”
Richardson
explains. “Instead, we’re talking about using ESG to optimize any
portfolio from
the risk-return perspective, not just an environmentally minded
portfolio. We are treating climate change and resource scarcity as a
pervasive global macroeconomic risk, not an uncertainty.”
ESG in the Short Term
Richardson clarifies ESG 3.0 by explaining it as “an attempt
to go under the surface and examine the actual steps businesses across
economies and markets are taking to reduce their carbon footprint and prepare
for greater resource challenges in the short-, medium- and long-term future.”
He says there is a wealth of reliable research that shows
this type of thinking is materially good for returns. While his firm focuses
mainly on portfolios that do have a top line environmental theme, the thinking can
be applied much more broadly.
“Just as a basic example, consider a diversified commodities
portfolio that takes this type of thinking into account,” Richardson continues.
“This is not going to be a green portfolio by any stretch of the imagination,
but it can certainly be advantaged by realizing that some mining companies or
resource transporters have a better environmental safety record and are more
skilled at efficiently using resources and minimizing waste or accidents
compared with others.”
These types of facts are easily gleaned
from data published quarterly by publicly traded companies, Richardson
adds, which is why the rapid advancement of data technology is also
opening new doors for ESG in retirement plans.
“Imagine if you
could open up a database that represented your entire pension portfolio
and could break down exactly what parts of your asset allocation program
are exposed to which ESG risks,” Richardson continues. “It goes back to
this principal of resource optimization, and how investing in the most
efficient companies with the best governance will bring the best
results, whatever the sector.”
Richardson says there are emerging ESG programs that can help
institutional investors look deeper into their portfolios with this type of
thinking in mind. A good catchall term for this is “resource
optimization,” he suggests.
“Whether you are motivated to try and reduce environmental
damage from commodity extraction or if you are simply looking for the most
returns from your commodity portfolio, this ESG 3.0 thinking will be helpful,”
Richardson says. “In a way we are talking about the breakdown of a barrier
between economic and environmental considerations, so personally I think the
DOL would do well by revisiting its stance.”
Opportunity Premium?
According to the Asset Owners Disclosure Project (AODP),
which publishes an annual report on the state of ESG investing among the
world’s largest asset holders, less than 2% of the more than $52 trillion
managed by the world’s 1,000 largest pension funds is invested in low-carbon
assets. Beyond large pensions, as much as 55% of all global investments are
exposed to climate risk, according to the “AODP 2013–2014 Global Climate
Index.”
Only five out of 1,000 funds surveyed achieved the report’s
highest, AAA, rating. A total of 27 asset owners scored an A rating or above,
compared with 22 last year.
Notably, these groups saw no strong correlation between
higher sustainability and lower returns. In fact, analysis of investment funds
earning the survey’s highest ratings shows that none of the most sustainably
run pension, superannuation, insurance and sovereign wealth funds are near the
bottom quartile of returns in their respective countries.
Those numbers should be enough to convince active managers
of the materiality of climate risk, AODP researchers argue. Also important is
that the risk attributes of climate change have a high likelihood of occurring
across nearly all geographic locations and economies, they say, making it
impossible for a given plan sponsor to isolate its portfolio.