Sponsors Remain Cautious on Impact Investing and ESG

2016 was an effective year for providers and recordkeepers searching to incorporate socially and environmentally conscious investment themes; yet fear of fiduciary risk and industry jargon are slowing progress among defined contribution (DC) plans.

Within impact investing comes Environmental, Social and Governance (ESG) investing; Socially Responsible Investing (SRI); and Economically Targeted Investing (ETI); several terms that can cause enough confusion for sponsors to turn their heads.

Sri Reddy, senior vice president and head of full service investments at Prudential Retirement, explains that each word offers a different foundational way for people to think about the broad category of impact investing.

“Within these labels there are investments that are exclusionary, meaning they won’t invest in certain industries, practices or types of companies,” he says. “There are investments that are more inclusionary, in that they seek out companies with certain behaviors, standards or causes.”

While the high-level terms ESG, SRI and ETI do share a connection, their meanings hold differences that are absolutely crucial for plan sponsors to understand. For example, according to labels used in a study by Prudential, SRI may involve avoiding certain businesses or sectors out of political or social concerns. ESG investing turns to the environmental, social and governmental stance within businesses; and ETIs are investments selected for the benefits they create, and the investment return to the employee benefit plan investor.  Such impact investments were traditionally made with the hope of achieving a social or environmental impact, but increasingly these strategies are all being touted for their potential to boost financial return as well.

Financially beneficial or not, one can see how different perspectives and beliefs among plan participants may make it tougher for DC plans to move down the path of impact investing, especially within ESG and socially responsible investing, says Matt Cirillo, senior analyst for retirement at Strategic Insight in Boston. (Strategic Insight is the parent company of PLANSPONSOR.)

“There’s so many different viewpoints on what it is, and it varies with individual investors—what sort of impact they may want to have,” he says. “If you’ve got an initiative to try and streamline a plan menu and provide the most effective lineup for your participants, how do you balance that with all of these options out there? How do you balance the desire of each individual participant with the overall goals of the plan?”

NEXT: Impact investing requires balance 

Beyond uncertainty around jargon, worries of fiduciary risk continue to turn plan sponsors away from impact investing. Even though the fairly recent Department of Labor (DOL) Interpretive Bulletin 2015-01 opened the door to the chance of impact investing within workplace-sponsored retirement plans, the threat of litigation towards plan sponsors attempting new approaches still strikes fear.

“Fear of litigation has led to a lack of innovation in plan menu design; unless everybody’s doing it, it’s hard to get the ball really rolling on something new,” says Cirillo. “If you look at all the court cases that have been brought recently against plan sponsors, it’s usually not because they’ve been doing the same thing that everybody else has. It’s because they’ve tried to do something different.”

However, Reddy believes the revised bulletin can go a long way to soothe the qualms of plan sponsors, enabling them to take the same cautious-but-assured approach they would seek with any other investment.

“The DOL essentially told plan sponsors they thought many were not using these investment styles because of worries about a heightened sense of fiduciary responsibility. They said, this bulletin is here to tell you that you do not have a heightened sense, you have the same fiduciary responsibility you would have for any other investment. So, be cautious, but don’t take on more worry than you otherwise would.”

The comfort in utilizing target-date funds (TDFs) and other traditional investments that have not yet widely embraced ESG/SRI makes it even tougher for plan sponsors to embrace impact investing. In addition, at least in the current market, financial outperformance of ESG/SRI/ETI is often marginal.

“Socially responsible funds generally perform on a relatively consistent basis with traditional investments, so if you were to compare a socially responsible large-cap index to say the S&P 500, over the long term you’re going to get comparable returns,” Cirillo says. “There’s not a tremendous amount of performance advantage that you’re going to get today. You’re also not going to be disadvantaged by investing that way, it’s really geared towards appeasing investors overall desire to do good.”

NEXT: Designing and delivering ESG and SRI

While plan sponsors are still weighing whether to employ traditional or impact investments, several firms are looking to combine the two. Recently, Natixis Global Asset Management filed a registration statement with the Securities and Exchange Commission (SEC) to roll out the first series of TDFs in the U.S. with investments focusing on ESG responsibility, expected to launch in the first quarter of 2017. Anticipated considerations for the investing strategies include labor standards, corruption, human rights, fair business practices and mitigation of environmental impact, according to the firm.

Cirillo believe Natixis’s inclusion of ESG investing in their TDFs is a positive and innovative move towards newer trends in the general market.

“In the target-date space, there are only so many ways that you’re able to differentiate yourself. You’ve got active/passive, you’ve got to/through, but besides that, there’s only so many ways that you can spin your story,” he says. “Up until this point, the presence of ESG in target-dates has been minimal to say the least.”

As impact investments are pooled with TDFs, they are also seeing a gain in popularity among younger demographics. According to the Schroders Global Investor Study 2016 released in November, which surveyed 20,000 end investors in 28 countries, the Millennial generation ranked ESG factors as equally important in outcomes when considering investments decisions.

Along with scoring the highest rating on the importance of poverty and climate change (7.2 out of 10), the study also found that Millennials were most likely to pull funds from companies with low ESG records; those associated with weapons manufacturing/dealing; or linked to oppressive political regimes.

Cirillo believes that for plan sponsors looking to incorporate impact investing, appealing to the Millennial age group may be the best option. For Reddy, whether it’s through Millennial impact or TDFs, impact investing serves as a force in achieving financial, social and environmental improvements.