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Even before the concept of ESG investing was fully developed, some investors had begun considering moral implications when weighing their investment decisions. These early approaches focused on avoiding certain “vice” industries (like tobacco, alcohol or gambling) or excluding investments originating from countries with poor human rights policies. Over time, the method progressed from mere avoidance to actively choosing companies for investments based on their efforts to reduce global warming or make an impact with diversity and inclusion, among other causes.
The list of ESG investors’ considerations continues to grow. Now more than ever, the COVID-19 pandemic has aimed a spotlight on companies’ “social responses”—how they are treating employees, customers, suppliers and society at large. Recently, transparent accounting, crisis management and strong supply chain management are also gaining popularity.
Companies can benefit in a variety of ways from maintaining a strong ESG strategy in their corporate governance and the 401(k) investment options available to their employees.
To support a meaningful ESG framework, companies should identify the key initiatives they most identify with and start focusing on a small number of purpose-driven goals that can be integrated at all levels of the organization. Successful ESG policies depend on commitment from the CEO, prioritization by management and communication to all stakeholders demonstrating the company’s dedication to the initiatives.
As investors and companies alike are learning—making investments based on ESG considerations does not preclude profit. A recent Goldman Sachs report, "Five Lessons Learned: Environmental, Social and Governance (ESG) and Impact Investing," identified that investors’ most frequent question on this topic concerns whether they must sacrifice returns in order to achieve impact. The report answers this question with a firm “no” and suggests that concessionary returns are not necessary. In fact, a cited meta-study of over 2,200 individual academic studies indicates that 90% showed a neutral or positive relationship between ESG and performance.
Bloomberg recently reported that investors have poured a record $22 billion into ESG exchange-traded funds this year, nearly tripling 2019's total.3 While the popularity of ESG investing is undeniable, many investors are advising caution, pointing out that the ESG designation is not regulated in the U.S. There is no consistent method for evaluating and defining an ESG classification. As these investment funds multiply in numbers, it will be important for investors to dig beyond surface labels and marketing materials to determine for themselves whether a fund truly delivers on its promises.
For many, an employer-sponsored defined contribution plan is their first—and potentially only—entry into the world of investing. Most employers have not widely added ESG funds within their defined contribution retirement plans, but America’s increasingly diverse and socially conscious workforce is driving this forward. At the same time, there is growing concern that the lack of standardization on ESG criteria may affect investors’ ability to make informed ESG investment decisions.
Building the personal financial literacy skills necessary to carefully evaluate investment decisions takes time. Employer-sponsored education and support is a critical part of helping employees build financial literacy. Ayco’s group education and financial wellness programs can help bridge this gap for employees.
Earlier this summer, the DOL turned its attention to ERISA retirement plans that wished to add fund choices based on ESG principles. The DOL issued proposed rules followed by a 30-day comment period, which received a high level of public response. Over 1,100 unique comment letters and 7,000+ signed form letters were submitted by members of the investment industry and the public. Most of the comments argued for the importance of ESG-themed investments and criticized the DOL’s view of ESG investing as outdated.
Last week the DOL announced their final rule, “Financial Factors in Selecting Plan Investments,” which updates and clarifies the investment duties regulation under Title I of ERISA. This ruling is intended to provide clear, regulatory guideposts for plan fiduciaries in light of recent trends involving ESG investing.
The ruling no longer singles out ESG—in fact, the final rules don’t even refer to “ESG.” Instead, they emphasize that retirement plan fiduciaries should only use “pecuniary” factors when assessing investments of any type. In other words, only factors that have financial implications. So, assuming ESG investments can measure up in a purely economic manner, there would be no restriction from including them in a fund line-up. ESG factors alone will also not disqualify a fund from being used as a qualified default investment alternative (QDIA). As long as the fund is assessed strictly on pecuniary factors and doesn’t state an objective other than the financial outcome of investors, the fund can be offered as an option. Our recent Insight provides more details about the DOL ruling.
The final rule is effective 60 days after publication in the Federal Register. While ESG options have not widely been adopted yet, the topic has been top of mind for many of Ayco's corporate partners—especially as more employees ask for these options.
Ayco works with several companies that offer ESG options within their 401(k) plan core investment lineups. A unique strategy we have seen companies implement or consider is highlighting the availability of ESG options within their brokerage window. This is an interesting option for providing ESG exposure for companies that currently offer a brokerage option, or may be considering one for the future.
As employers move forward within the new guidelines, effective communication and participant education are critical. ESG investment options carry unique characteristics and complexities. Employees will need more assistance to make informed investment decisions. Ayco’s advisors can help employees navigate these complicated topics, tailoring the experience to meet each individual’s specific needs.
For further background on the rising importance of ESG factors, check out these additional resources from Goldman Sachs:
1COVID-19 Corporate Response Tracker, JUST Capital and the Harris Poll, May 2020
For disclosures relating to this article, please click here.
By Brandon Ross
Insights from Ayco InnerCircle 2021