Investing May 3, 2021

ESG Investing Has Extended to Fixed Income

Asset managers say applying ESG screens to fixed income opportunities offers another prism of assessing risk.

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While interest in investing in environmental, social and governance (ESG) factors through equities has been gaining steam, so too has interest in applying ESG factors to the fixed income portion of portfolios.

“We have seen strong adoption of ESG in equities in the past few years, and that has now extended to fixed income,” says Hitendra Varsani, executive director of MSCI Research. “Only in the past few years has the demand for ESG fixed income opportunities accelerated.”

MSCI Research seeks out ESG fixed income and equity opportunities not by looking at a particular security—be it a bond or a stock—but by screening issuers for 37 key factors that MSCI Research has determined identify true commitment to ESG, Varsani says. This research is conducted by more than 200 analysts at the firm.

The 37 key issues are mostly centered on risk factors to rate each issuer on their ESG effectiveness, he says. “From there, we use the research to conduct various analytics, indexes and additional research,” Varsani says. “In the past, ESG was viewed from an impact or values-based perspective. Today, however, investors now recognize ESG as having material impact on performance, which is why many are adopting ESG across their entire portfolio. ESG screens can lead to better financial characteristics and fundamentals, like cash flow, volatility and risk exposure.”

He adds that fixed income portfolios have historically been organized by duration and credit quality. ESG, Varsani says, provides another dimension of financial assessments beyond the balance sheet and cash flow metrics to reveal issues that can impact the successful running of the business and risk mitigation. “That can lead to better outcomes for investors. Being less exposed to market downturns improves risk-adjusted returns. For ESG fixed income investments, it is less about the upside and more about risk mitigation,” he says.

Brian Woolfolk, head of the institutional division at Pacific Life, says the company has just introduced a sustainable bond framework, under which it can issue sustainable bonds through the capital markets group of its institutional division.

One key element of the sustainable bond framework is a commitment to investing an amount equal to the net proceeds of the issuance of sustainable bonds in one or more of the following projects: green buildings, renewable energy and energy efficiency, sustainable water and wastewater management, terrestrial and aquatic biodiversity, clean transportation, and access to essential services such as education and affordable housing.

Like Varsani, Woolfolk says applying ESG screens to fixed income investments can lead to “superior risk-adjusted investments that provide scalable and value-added solutions to our clients.”

David Norris, head of U.S. credit at TwentyFour Asset Management, cautions that while some issuers of ESG stocks have made information on their criteria available to the market, information on ESG fixed income opportunities is not as prevalent. “The biggest issue for potential investors in these funds, particularly in the U.S., is finding the information on their ESG criteria,” Norris says.

Bradford Cornell, emeritus professor of finance at the Anderson School of Management at UCLA, maintains that green bonds are more expensive than regular bonds. There aren’t that many green bonds on the market, he says, probably because if a green company wants to fund an ESG-friendly project, such as a wind farm, it can simply issue a regular bond at a lower interest rate. “The only reason it might issue it as a green bond is marketing,” Cornell says.

He says he believes ESG investing, be it in equities or bonds, is a passing fad. “As it stands now, some ESG investments include Apple, Google and Facebook,” Cornell says. “These is some dispute as to how these funds are getting away with this, and the SEC [Securities and Exchange Commission] is starting to look into this, particularly because ESG funds typically have added fees due to their additional screening. I tell investors to be careful about ESG fixed income investing. If the issuer is getting the benefit from the strategy, it is coming out of the pocket of the investor.”

Compliance May 3, 2021

Lawsuit Alleges Participant Price for University of Tampa Plan Is Too High

The plaintiff argues that similar university lawsuit settlements have helped to drive down fees, and changes the university made last year were too late.

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A participant in the University of Tampa’s 403(b) plan has filed a lawsuit claiming that over the past six years, plan participants have paid at least $3 million in administrative fees, which it says is more than 10 times what they should be.

The University of Tampa says it has no comment at this time about the lawsuit.

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The the complaint says the plan’s recordkeeper, TIAA, has been able to extract “such grossly excessive fees” because the fees are based not on services it provides to the plan but on a percentage of assets in the plan.

The plaintiff says it took the university nearly 14 years to obtain a recordkeeping deal from TIAA that identified exactly what the plan and its participants were being charged. From 2006 through mid-2020, the TIAA recordkeeping agreement lacked any specifics as to amounts charged for recordkeeping services performed by TIAA, the plaintiff says, adding that the fees skyrocketed during this period.

The complaint notes that this action is similar, but narrower in scope, to roughly 20 other lawsuits alleging a university breached its Employee Retirement Income Security Act (ERISA) fiduciary duties by allowing TIAA to collect excessive administrative fees from the university’s retirement plan. It says university plan participants are fighting back and demanding that TIAA’s fees be reduced.

“It appears TIAA is willing to meaningfully reduce its fees if universities will just ask,” the lawsuit says. “By way of example, shortly after the University of Chicago was sued, it announced to its plan participants that it renegotiated TIAA’s administrative fees and that it successfully reduced fees on an annual basis by several million dollars.”

The complaint also notes that many of the universities that were sued settled the claims against them on a class-wide basis and lowered plan fees in the process. After listing universities that settled similar lawsuits and the settlement amounts, the complaint says, “These similar lawsuits and the class-wide settlements have reduced administrative fees in similar plans and added millions to the retirement savings of hard-working university employees.”

As for the University of Tampa, the plaintiff alleges that instead of leveraging the plan’s tremendous bargaining power to benefit plan participants, the university failed to take proper measures to understand the real cost to plan participants and make sure fees were reasonable.

The complaint notes that the university’s Form 5500 identifies TIAA as receiving “indirect compensation” but states the amount TIAA received is “0” or “none,” which the plaintiff says is false.

The university uses revenue sharing payments to pay for recordkeeping, according to the complaint. The plaintiff concedes that revenue sharing is not a violation of ERISA but says it can lead to “massively excessive fees if not properly understood, monitored and capped.”

“If a fiduciary decides to use revenue sharing to pay for recordkeeping, it is required that the fiduciary (1) determine and monitor the amount of the revenue sharing and any other sources of compensation that the provider has received, (2) compare that amount to the price that would be available on a flat per-participant basis, or other fee models that are being used in the marketplace, and (3) ensure the plan pays a reasonable amount of fees,” the lawsuit states.

The plaintiff contends that a “flat price based on the number of participants in the plan ensures that the amount of recordkeeping compensation is tied to the actual services provided by the recordkeeper and does not grow based on matters that have nothing to do with the services provided, such as an increase in plan assets due to market growth or greater plan contributions by the employee.” However, the complaint goes on to say that the plaintiff isn’t alleging that the university was required to use a direct payment arrangement but is simply providing details on how direct payment methods operate to partially illustrate that the fees plan participants are paying to TIAA are excessive and that “the university should have done more to investigate, monitor, request, negotiate and secure reasonable administrative fees for plan participants.”

The plaintiff says determining the price that would be available on a flat per-participant basis, or the price available under other fee models for a $100 million dollar plan requires soliciting bids from competing providers. “Benchmarking based on fee surveys alone is inadequate,” the complaint says.

The lawsuit notes that on March 20, 2020, the university and TIAA entered into a revised recordkeeping services agreement which included actual recordkeeping services costs, charged as basis points (bps). In the revised agreement, TIAA agreed to a soft cap of its revenue sharing fees. However, the plaintiff says the university could and should have negotiated and secured reduced fees long before.

“The defendant could have capped the amount of revenue sharing to ensure that any excessive amounts were returned to the plan as other loyally and prudently administered plans do, but failed to do so until just recently,” the complaint states. “The defendant’s failure to cap the amount of revenue sharing cost the plan and its participants … hundreds of thousands of dollars in losses.”

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