Compliance October 27, 2023

State AGs Appeal Dismissal of Suit Challenging DOL’s ESG Rule

The Department of Labor’s defense continues on two tracks, one in Wisconsin, and 2another in the 5th Circuit.

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A group of 26 state attorneys general have appealed to the 5th U.S. Circuit Court of Appeals the dismissal of their complaint challenging the legality of the Department of Labor’s final rule permitting environmental, social and governance factors to be used when selecting retirement plan investments.

The states’ lawsuit, Utah et al. v. Walsh, was dismissed on September 21 by the U.S. District Court for the District of Northern Texas because the Employee Retirement Income Security Act of 1974 does not specifically forbid ESG factors or a tiebreaker test that permits non-financial factors to be used in ERISA-covered investment decisions. Additionally, the DOL’s final rule states that fiduciaries must still act prudently and cannot subordinate financial factors to non-financial ones.

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The appeal notice did not spell out the legal argument for the appeal. The appeal was also signed by industry plaintiffs Liberty Energy Inc. and Liberty Oilfield Services LLC, two fossil fuel firms; and Western Energy Alliance, a fossil fuel lobby.

The original complaint argued that ESG investing is unlawful under ERISA because ESG factors are non-financial factors and would undermine retirement savings in order to advance political and ethical goals, especially in terms of environmental and climate concerns. The attorneys general argued it would hurt retirees’ savings in their respective states and would also harm investment in the fossil fuel industry, hurting tax revenues in those states.

Of the 16 judges on the 5th Circuit, which hears cases from Louisiana, Mississippi and Texas, 12 were appointed by Republican presidents. While it is considered on the conservative end of the appellate courts, U.S. District Judge Matthew J. Kacsmaryk, who dismissed the case, is also widely considered conservative because of his rulings on abortifacients and immigration policy.

In his dismissal order, he acknowledged that the suit should be dismissed, even though “the Court is not unsympathetic to [the] Plaintiffs’ concerns about ESG investing, [but] it need not condone ESG investing generally or ultimately agree with the [DOL] Rule to reach this conclusion.”

A separate lawsuit challenging the ESG rule in the U.S. District Court for the Eastern District of Wisconsin, Milwaukee Division, is still ongoing in Braun, Luehrs v. Walsh. Its plaintiffs make the same objections to the rule: that ESG investing will allow sponsors to select imprudent investment menu options for political reasons that will ultimately undermine investment returns in retirement plans.

The DOL’s rule, finalized in November 2022, does not require ESG factors to be used in investment selection. It permits them, but only to the extent that ESG issues are financial considerations and that the investment is otherwise prudent. Non-financial factors may only be considered as a tiebreaker between two options which both equally serve the interests of the plan.

The DOL rule also permits sponsors to include investment menu options that take participants’ non-financial interests and preferences into account, as long as those menu options are still prudent. This provision is intended to increase plan participation by allowing sponsors to provide participants with an incentive to use the plan that goes beyond economic returns. This provision has not been a focus of either lawsuit.
Products October 27, 2023

Vanguard Target Date Retirement Fund Series Turns 20

The low-cost investment vehicle has come to dominate retirement plan savings, but industry voices are calling for more personalization.

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On October 27, 2003, the Vanguard Group debuted its first retirement target-date fund series.

20 years later, the low-cost, index-based asset manager now accounts for 37% of the $1.58 trillion TDF market among the largest 10 providers, according to the latest data from Simfund, which, like PLANADVISER, is owned by Institutional Shareholder Services Inc.

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Its closest competitor, Fidelity Investments, comes in at 21%, followed by American Funds (16%), T. Rowe Price (10%) and TIAA (5%).

Vanguard’s success has come, in part, due to the popularity of a “set it and forget it” investment that can be used in retirement plans to adjust the risk profile based on a participant’s age.

“20 years ago, Vanguard brought our low-cost, index-based approach to target-date funds. The impact has been profound,” says John James, the managing director of Vanguard’s institutional investor group. “Target-date funds have become a cornerstone of U.S. retirement plans.”

TDF growth started out slow.According to Simfund’s tracking, the largest providers had $123 million in TDF assets in their infancy in 1990. By 2003, when Vanguard launched its TDF series, the market had ballooned to $26 billion. It was spurred further along when the Pension Protection Act of 2006 made TDFs available for use as a qualified default investment alternative in retirement plans. A decade later, TDF assets had surpassed $500 billion, and by 2017, they topped $1 trillion.

According to Vanguard’s own America Saves research, 96% of retirement plans managed by the firm offered target-date funds, as of the end of 2022.

“Accessible and affordable target-date funds streamline asset allocation, diversification and rebalancing, while personalized advice helps investors stay on track toward multiple goals,” James says.

Getting Personal

But while TDFs have grown in the retirement sector, so have calls for more personalized investment and advice options for participants to cater outcomes beyond an age-based glide path.

Managed accounts, which provide individualized investing and advice, are growing both in size and interest, as plan sponsors and advisers seek to provide a personalized option for participants at volume, according to a report released this week by Cerulli Associates and managed account provider Edelman Financial Engines.

More than half (52%) of consultant-intermediated defined contribution plans offer managed accounts, according to Cerulli. Among that set, 5% use it as part of a dynamic qualified default investment alternative, which means participants are transitioned into a managed account later in their career, and 3% use it as the plan QDIA.

Meanwhile, TDF options themselves are being built to be more personalized. There are numerous customized TDF options that can cater to plan sponsors and their participant pool. In 2021, PIMCO announced a collaboration with Morningstar Inc. for TDFs that include age, salary, assets, savings rate and company match rate to create more personalized allocation. In 2022, Capital Group, which runs American Funds, and Morningstar, announced Target Date Plus, a personalized TDF series with allocation advice tailored to a retirement saver’s specific needs and objectives.

Ron Surz, a frequent retirement commentator and creator of his own TDF solutions, believes the investment vehicle is a good idea that “has been cannibalized for profit” by what he sees as an oligopoly of providers.

“My biggest concern is the lack of protection against Sequence of Return Risk,” says Surz, referring to the risk of negative market returns when close to or in retirement.

Surz says TDFs at his Target Date Solutions, along with those of Dimensional Fund Advisors and the Thrift Savings Plan, protect the account balance at the target date by putting the majority of investment in Treasury inflation-protected securities.

He believes, and has written a book saying, that Baby Boomers are at risk of losing a major chunk of their retirement assets should a market crash similar to the financial crisis of 2008 hit, due to the amount of their savings held in TDFs. “They are going to spend this decade in the risk zone,” Surz says. “Hopefully it doesn’t happen, but the possibility is there.”

In terms of personalization, Surz recently launched his Soteria Personalized Target Date Accounts, which allows an individual to choose between three different glide paths. Participants can adjust those paths depending on their circumstances, along with being able to change their planned retirement date.

He envisions Soteria, named after a Greek goddess of safety, as a tool advisers and recordkeepers can also build from the best funds available in the market, as opposed to proprietary offerings.

Evolving Market

James of Vanguard agrees with the personalization shift, noting the approach depends on participant need.

“Retirement plans are evolving toward offering more personalization,” he says. “This is an important development, particularly for highly engaged retirement savers or investors working toward multiple financial goals. Target-date funds offer investors a hands-off approach that appeals to many retirement savers. On the other end of the personalization spectrum, highly customized advice from a robo-adviser or a CFP may be a better fit for investors seeking more support. We see the industry steadily expanding choices for investors along this continuum of personalization.”

By the end of 2022, he notes, more than three in four participants in Vanguard-managed plans had access to managed account advice.

Even among calls for personalization, TDFs show no signs of slowing down as the leading investment vehicle in retirement plans. As of the end of 2022, 96% of respondents offer TDFs, with 46% of all plan assets invested in TDFs, according to 119 plan sponsors surveyed by NEPC LLC.

The vehicle has also, according to Vanguard, both democratized investing and helped individuals avoid having to trade on their own or pay an adviser. The asset manager notes that the fraction of participants it serves holding broadly diversified portfolios rose from 42% in 2006 to 79% in 2022.

Meanwhile, 94% of participants in Vanguard-managed plans did not initiate any trades, the result of 15 years of declining self-activated trading, which the firm attributes in part to increased adoption of TDFs.

 

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