DC Plans Embrace ESG Funds
Two experts with Northern Trust Asset Management, Sabrina Bailey, global head of retirement solutions, and Mamadou-Abou Sarr, global head of environmental, social and governance (ESG) investing, recently penned a helpful analysis examining the proper role of ESG in defined contribution (DC) retirement plans.
Roughly two years after the Obama administration moved to open up the use of ESG investing factors under the Employee Retirement Income Security Act (ERISA), the pair say they see tremendous interest from defined contribution plan clients to use ESG to “mitigate risk, seek opportunities and offer more options to their participants.” ESG can help a sponsor meet all of these goals, Bailey and Sarr agree, but there are some considerations that must be taken into account to ensure ESG themes do not conflict with the strict tenets of ERISA.
“First and foremost, are there strong organizational values that should be reflected in the retirement plan investment menu?” Bailey says. “This is the beginning of defining the potential role of ESG in a DC plan. Women and Millennials, in particular, are creating demand for investments that align with the corporate values of their employers.”
Of course, under ERISA, there are limits on the extent to which plans can consider social values when picking investments, Sarr advises. Even with the Obama-era expansion of ESG in DC plans, the sponsor must carefully consider the risk-return profile. If an investment can reasonably be expected to underperform because of its commitment to a certain set of values, it is probably not a good fit for the DC world. This was more of an issue in the past because ESG funds were typically designed to simply “screen out” certain stocks—say, alcohol, tobacco or firearms companies. Today the product set is far more sophisticated and takes a more positivist approach, leveraging ESG analysis to improve decisionmaking, rather than simply relying on negative screens.
“ESG analytics and ratings have improved dramatically over the years,” Sarr observes. “ESG ratings can now be used as a risk mitigation technique or an opportunity-seeking technique.”
The idea is that the highest-rated companies from the ESG perspective should stand out against their competitors and should have lower resource-scarcity risk.