SRI Holdings in ERISA Plans Gaining Ground, but Concerns Remain

The U.S. Sustainable Investment Forum (U.S. SIF) recently published the “Report on U.S. Sustainable, Responsible and Impact Investing Trends 2018” that includes data indicating growth in the use of what it calls sustainable, responsible and impact (SRI) investment options in Employee Retirement Income Security Act (ERISA) retirement plans.

The organization reports an uptick in SRI holdings from 2014 to 2016. The data was evaluated in light of Department of Labor (DOL) guidance on what it called economically targeted investments (ETIs). In October 2015 the DOL rescinded its 2008 bulletin on ETIs, which had discouraged some plan fiduciaries from considering what the industry calls environmental, social and governance (ESG) investments. But Interpretive Bulletin 2015-1 said “fiduciaries need not treat commercially reasonable investments as inherently suspect or in need of special scrutiny merely because they take into consideration environmental, social or other such factors.” It went on to say that ESG funds can be proper components of a fiduciary’s financial analysis. A Field Assistance Bulletin in 2018 about environmental, social and governance ESG investing did not technically alter any previous DOL guidance related to ESG funds.

The latest data available indicates that the number of plans investing in SRI funds grew 70% and assets in SRI plans grew 71% from $2.70 billion to $4.61 billion from 2014 to 2016. 

Meg Voorhes, director of research at US SIF says, “We have specialized research in the report but unfortunately it is a lagging indicator. We have 2016 year-end data for direct-filing entities that submit Form 5500 to the DOL and that report their underlying holdings.”

What would encourage more ESG offerings in retirement plans?

Despite the uptick in ERISA plans using ESG investment options, some are still wary of doing so.

There are two ways of encouraging more ESG offerings in retirement plans, according to Lisa Woll, CEO of US SIF and the US SIF Foundation. “From the bottom up or the top down. You can talk to the corporate plans, the plan sponsors and the participants—I think [doing so] important. We’ve spent more time talking to members of businesses for social responsibilities for them to drive adoption in their own companies; we’ve put out numerous “how-to” guides for plans to add these options, but I also think that you have to drive knowledge for the participants themselves and have them ask [retirement plan sponsors] to add ESG options.”

Jonathan Bailey, managing director and head of ESG Investing at Neuberger Berman, an investment management firm, says it has seen significant growth and interest in ESG investing by corporate plans that are not necessarily companies that are leaders in sustainability because their participants want to have these choices. 

Proving performance

According to Cerulli researchers, one of the biggest hurdles in turning ESG interest into actual investment, both by current users of ESG portfolios and non-users, is the perceived impact on investment performance.

However, Calvert Investments analyzed data on ESG investing in various ways between June 2000 and December 2014, starting with ESG screens, then moving to stand-alone ESG investing and finishing by looking at a combination of traditional and ESG investing. “We find empirical evidence across each of these approaches that incorporating ESG factors into investment decisions improves the investment selection process and enhances risk-adjusted returns,” Calvert says. From December 31, 2008, through December 31, 2014, the Calvert Social Index (CSI) outperformed the Russell 1000 Index by 142 basis points on an annualized basis, Calvert says.

More recently, Arnerich Massena said, “Businesses that incorporate sustainable practices are stronger and better prepared for the future, as well as more attractive to consumers.”

RBC Global Asset Management’s third annual Responsible Investing Survey found a dramatic shift in attitudes toward ESG investing is visible among U.S. institutional investors, as 24% said they believe an ESG-integrated portfolio would outperform its counterpart, nearly five times the percentage in last year’s survey.

Eliminating confusion from DOL guidance

Given some of the strong language used to warn retirement plan fiduciaries against placing other interests ahead of the financial benefit of their participants, the latest DOL bulletin on the topic of ESG investing created some confusion. According to the DOL, the “sub-regulatory action” was not meant to substantially change the status quo with respect to ESG investing under ERISA, but instead merely to clarify how the new administration views existing regulations in this area.

An analysis of the most recent DOL bulletin shared by Northern Trust Asset Management says the DOL has confirmed once again that pension managers can and should feel comfortable using ESG factors as an input in evaluating potential risk and financial return. According to Northern Trust, the most recent DOL bulletin is “meant to clarify and reinforce the prudent fiduciary investment process that must always take place,” rather than to say that ESG investing rules are reverting to the stricter standards that existed prior to the 2015 reforms.

In a report, the Government Accountability Office (GAO) says in other cases where plans may face complexity, such as selecting a target-date fund or monitoring pension consultants, the DOL has provided general information, including items to consider and questions to ask. It suggests that the DOL do the same with ESG investing.

ESG screening in more asset classes and more reliable data

My-Linh Ngo, ESG investment specialist for RBC Global Asset Management’s London-based BlueBay Asset Management division, points out that equities have long been the primary focus of ESG analysis and investing, but these days ESG analysis is quickly moving beyond equities. Thirty-percent of respondents in the U.S. to RBC Global Asset Management’s third annual Responsible Investing Survey said it is important to incorporate ESG into fixed-income considerations.

“Our company has a core belief that ESG considerations are investment additives, not a hindrance to performance,” Ngo says. “Thinking about ESG helps us to generate a more holistic and informed view of how companies are performing, or are likely to perform in the future. So, we are applying an ESG risk overlay across all of the fixed-income assets we manage. It is not something that we limit to niche funds.”

Data shared by Natixis Investment Managers shows managers of corporate and public pension funds, foundations, endowments, insurance funds and sovereign wealth funds are embracing greater use of ESG investing programs. However, the research shows 45% of institutional investors feel it is difficult to measure and understand financial versus non-financial performance considerations when establishing ESG programs.

Shared by fewer investors but perhaps even more concerning is the fear that publicly owned companies may be “greenwashing” reported data to enhance their image from the ESG investing perspective, cited by 37% in the survey pool. This is the same number that cited concern about a general lack of transparency and standardization by companies when it comes to reporting ESG-related information for the purposes of securities disclosures.

“As industry acceptance of ESG integration has accelerated and becomes mainstream, there will be greater focus on ESG-related investment research and its application in the portfolio management process,” says Habib Subjally, senior portfolio manager and head global equities at RBC Global Asset Management (UK) Limited. “And as the demand for responsible investment solutions grows, asset managers and consultants will increasingly be called upon to offer guidance to their clients about responsible investing options that support their long-term financial goals.”