Many View New DOL ESG Ruling as an Incentive to Sponsors

While environmental, social and governance (ESG) investing is not very prevalent in retirement plans, many executives in the retirement plan industry think the latest Department of Labor (DOL) ruling on ESG investing will encourage more plan sponsors to consider such approaches.

While the DOL kept the ESG nomenclature in the preamble of the ruling, it replaced it in the body with “pecuniary” considerations, saying that is what sponsors need to consider when weighing the merits of a fund. Furthermore, when considering two funds that are economically similar, the DOL said, sponsors can consider the merits of ESG approaches.

Matt Sommer, senior managing director of the retirement strategy group at Janus Henderson Investors, notes that despite the new DOL ruling, the acceptance of ESG investments by sponsors will take a wholesale change in their thinking about the merits of such investments, as the Plan Sponsor Council’s annual survey last year found that less than 3% of retirement plans offer an ESG option in their investment lineup.

That said, Sommer notes there are many studies that have found ESG investments’ performance to be very strong.

“There is empirical data that shows there is a correlation between ESG and corporate performance,” Sommer says. “There was an article in the November 2015 ‘Journal of Finance and Investment Analysis’ that examined the findings of 2,000 studies that looked at the correlation between ESG and performance and found the majority found there to be [a correlation]. Similarly, Bank of America Merrill Lynch studied the markets between 2014 and 2019 and found that the 20% top-rated ESG companies outperformed the S&P 500 and had lower volatility. So, just as the DOL rule asks sponsors to focus on pecuniary factors, this final rule is a net positive for ESG investing. We think demand for ESG will really increase throughout North America, as it has in Europe.”

However, investment committees move slowly on any new development in the retirement plan space, Sommer says, so Janus Henderson recommends a three-step process for its clients considering ESG investments.

First, plans with a brokerage window could investigate what ESG investments might be available there and begin to incorporate information about ESG investing into their participant education, Sommer says.

Second, they could consider adding a very broad-based ESG fund to their lineup because there are so many different iterations of ESG and peoples’ values vary widely, he says.

Thirdly, sponsors can ask their advisers to find out whether the portfolio managers of the funds that are already in their lineup apply ESG screens to their investments, as this is becoming more common among portfolio managers, Sommer says.

Brendan McCarthy, head of defined contribution investment only (DCIO) at Nuveen, agrees that “the belief that ESG investors are giving up performance is outdated. The market has shifted to using ESG to reduce risk and improve performance. With the final language in the DOL ruling, we believe it absolutely will continue to allow for the growth of ESG in retirement plans, outside of the QDIA [qualified default investment alternative]. It has almost become a standard practice today to utilize ESG as a pecuniary factor in assessing investments.”

Melissa Kahn, managing director for the defined contribution (DC) team at State Street Global Advisors, says it’s important to note the significance of the DOL taking out references to ESG investing in the operative language of the final rule and replacing it with the word pecuniary. However, references to ESG investing are “still extensive in the preamble, which is troubling.”

With the incoming Biden administration, however, Kahn says it is possible the new president could “issue an executive order to ask all regulatory agencies to take a look at regulations with regards to climate change. I think that will happen with ESG regulation. However, until we have a clearer stance from the Biden administration, people are going to be a little reluctant to put ESG investments in retirement plans.”

However, Josh Ulmer, senior vice president at SeaPort Group, Morgan Stanley Institutional Wealth Services, says he doesn’t believe the new DOL ruling should materially change sponsors’ attitudes about ESG investing because the ruling calls on sponsors to act in the best interest of participants and to adhere to a prudent process from start to finish, just as prescribed by the Employee Retirement Income Security Act (ERISA).

“Asking sponsors to hold ESG investments to the same standards as all other investments is not a deviation from what a retirement committee should already be doing,” he says.