Gone are the days when socially responsible investing is defined as an investment strategy that seeks to avoid companies that profit from “sin” (alcohol, tobacco, gambling, firearms, etc.). The investment strategy has adopted a holistic focus on environmental, social and governance issues (ESG), according to a white paper by Karen Kaufman-White, investment research associate at Strategic Benefit Services.
According to Kaufman-White, ESG issues can have a material impact on a company’s performance via reputational, operational, and financial risks or via commercial opportunities (such as clean technology innovations to accelerate the transition to a low-carbon economy). And, she points to “a growing body of research” that suggests companies with a holistic consideration of ESG measures have better long-term financial outcomes and may provide more opportunities for profitable investing endeavors.
However, ESG is not an asset class, and a prudent retirement plan fiduciary must still evaluate potential investments based on their fundamentals and compared to the peers within their respective asset classes, Kaufman-White points out. Thorough due diligence is still required. As per the most recent U.S. Department of Labor Field Assistance Bulletin on the subject, plan sponsors cannot sacrifice their fiduciary duty to the participant solely for a social cause.
She notes that the Morningstar Sustainability Rating measures the holdings in a mutual fund based on how well a company manages its environmental, social and governance risks and opportunities, then rates the company against its category peers. The ratings are applied across all funds, not just those that self-identify as socially responsible. Morningstar further reports that sustainable funds can now be found across 56 different Morningstar categories. Accordingly, Morningstar recently changed its sustainability ratings system to expand the peer group to include global categories, providing larger, more stable comparisons.
However, obstacles to good comparisons include a lack of uniform standards; data are sparsely available and inconsistent and there is no standard vocabulary. Disclosures are voluntary and many companies choose not to report; thus, the data are incomplete. However, Kaufman-White indicates she believes that over time, more robust data will become available, facilitating enhanced reporting capabilities and standardization.
For retirement plan participants, ESG investing can be viewed as investing with an eye to the future—contributing to the sustainability of resources and the planet. The concept of ESG investing has evolved to incorporate the alignment of financial success with a positive social and environmental impact.
Kaufman-White says plan sponsors have the opportunity to help participants understand that performance historically has not been sacrificed by ESG investing; it has been at least neutral, if not beneficial, according to many studies. “Plan participants, especially those in nonprofit settings, may want a connection between their values and their financial goals, which can be advanced by the availability of ESG options in the plan’s investment menu,” she concludes.The white paper, “Doing Good While Doing Well,” may be downloaded from here.