A DOL ESG Investigation Story

An adviser’s message to his peers is to not fear including ESG factors in investment analysis.


Todd Kading, co-founder and chief executive officer of LeafHouse Financial in Austin, Texas, says that even before environmental, social and governance investing was big news in the industry, he felt there would be a market for it among his clients. “Because it was so big in Europe,” he explains. “I especially thought there would be an interest from nonprofits and younger retirement investors.”

Kading says he never liked the exclusionary investment practices of what were once called “socially responsible investing,” but he felt that “E,” “S” and “G” were good mechanisms to judge whether an entity he? invested in had long-term sustainability.

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So, his firm set out to develop an ESG evaluation tool. “Going back to the [Department of Labor’s] 2018 guidance, it said to do all of your ‘normal’ investment research, and if an investment passes that and it passes ESG screenings as well, then it is ok to select that investment,” he notes. “So, we went with that.”

The result was “LIST,” which stands for LeafHouse Investment Sustainability Technology. “We got the word out that we are a third-party fiduciary offering an ESG-centric product for all plan sponsors that are interested,” Kading says.

He explains that the technology uses LeafHouse’s normal GPA—or Grade Point Average—screening. Then investment experts determine whether the investments are appropriate quantitatively and qualitatively. Finally, ESG factors are considered. Investments must pass all three processes to be selected.

The DOL Comes Calling

Then the DOL took a new stance. Near the end of Donald Trump’s presidency, it published a final rule that said retirement plan sponsors should only consider “pecuniary,” or performance-related, factors when selecting investments for their investment lineup, rather than expressly limiting the use of ESG funds. It took a softer stance than the initial proposed rule, which drew intense criticism.

Kading speculates that the DOL contacted his firm wanting to investigate it’s ESG screening process because it had done no research prior to issuance of the new rule. He’s not the only one that says this. At the time the DOL proposed its rule, Lisa Woll, CEO of US SIF: The Forum for Sustainable and Responsible Investment in Washington, D.C., said in a statement, “The proposed rule suggests, but without evidence, that the growing emphasis on ESG investing may be prompting ERISA [Employee Retirement Income Security Act] plan fiduciaries to make investment decisions for purposes distinct from providing benefits to participants and beneficiaries and defraying reasonable expenses of administering the plan.” [emphasis added by PLANADVISER]

“[The DOL] just wanted to investigate someone prominently using ESG investing in ERISA plans,” Kading says. And he jokes, “because our firm is so good at marketing, we stood out.”

This led to nearly a year of back and forth with the DOL. As is proper with any DOL investigation, LeafHouse brought in its attorney to make sure it was complying with everything the DOL was asking.

Kading says his firm definitely provided some education to the DOL, adding that it’s understandable given that the investigators are not industry veterans. “At first, they wanted to look at every single plan client, but we had to explain that some plans don’t use ESG screening,” he says. “Then they wanted to look at all funds in all plans that use ESG, but we had to educate them that only some funds use ESG screening.”

Finally, the DOL agreed to look at only the clients and funds that used LeafHouse’s LIST.

The investigation wasn’t a daily task; it happened in phases. “The first phase was having our attorney look over the DOL’s requests. It took a couple of months to define the scope of the investigation,” Kading explains. “There were a couple of months of working with the DOL on how much they get into our files, and there were a couple of months of educating the DOL about what it all means.”

Finally, LeafHouse received a letter from the DOL that it was closing the investigation. “My interpretation was that we were doing everything right,” Kading says.

He acknowledges that a DOL investigation sounds scary, but he points out that everything the agency does is an investigation. “It doesn’t mean anything is wrong.”

“The negative thing about all the publicity [surrounding the investigation] isn’t that it happened,” Kading says. “It’s that advisers might get scared from doing something about ESG investing.”

His message to his peers: “You shouldn’t be afraid to have these conversations with plan sponsors.”

ESG Interest ‘Relatively Weak’ for Do-It-Yourself Retirement Investors

Among new, self-directed DC retirement plan participants, ESG fund allocation is ‘relatively modest when offered in the core menu,’ according to research from PGIM and EBRI.

Environmental, social and governance investments are not as high on the list of self-directed retirement plan investors as some surveying suggests, according to new research.

The research, by PGIM and the Employee Benefit Research Institute, examined the allocation decisions of 9,324 new defined contribution plan participants, across 108 DC plans, who are directing their own accounts and where there is at least one ESG fund available in the core menu.

“Overall interest in ESG strategies among these participants is relatively weak, with only 8.9% of participants having any allocation to an ESG fund and average allocations to ESG strategies of only 18.7% among those holding any ESG funds,” wrote the authors, David Blanchett, head of retirement research at PGIM DC Solutions and Zhikun Liu, senior research associate at EBRI.

The average allocation to ESG funds among the participants in the analysis was 1.7% of the total assets and or balances for invested participants, the research shows.  

“I think what the results reveal to plan sponsors is simply that demand for ESG funds in defined contribution [plans] may not be as high as suggested by some surveys,” Blanchett explains in an email. “It’s not that some participants don’t want ESG funds, it’s that there doesn’t appear to be an especially high demand today (i.e., not that much more than other investments available on the core menu).”

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For the analysis, approximately 100,000 participants who are self-directing their accounts – do-it-yourself investors – were culled based on several criteria, including age and years of retirement plan participation.

Blanchett explained retirement plan participants who do allocate to ESG funds are likely driven to invest by naïve diversification rather than the strong conviction to allocate. The self-directed plan participants could be randomly picking funds to build a diversified portfolio, Blanchett said.

“For example, if there are 10 funds available, and I allocate 10% to each one, I’d be diversifying my portfolio by holding multiple funds, but I wouldn’t necessarily have the most diversified portfolio depending on the similarity of the funds I’m selecting,” Blanchett explained.

“No plan offered more than five ESG funds, and the vast majority – approximately 76% – offered only one ESG fund,” the paper states. “This suggests it would be relatively difficult to build a diversified portfolio using only the ESG funds in DC plans currently.”

Among all 108 plans studied, the largest number, 82 or 75.9% of all the plans studied, offered one ESG fund; 17 plans, or 15.74%, offered two ESG funds; five plans, or 4.63% of plans, offered three ESG funds; and three plans, 2.78% of the total, offered four ESG funds.

The researchers concluded that the paper “paints a mixed picture about the actual participant interest, and drivers of demand for ESG funds in DC plans and suggests that plan sponsors should take a thoughtful approach when considering adding ESG funds to an existing core menu.”

The research methodology limited participant respondents to new defined contrition plan enrollees, according to the paper.

The research was narrowed “to ensure we are capturing participant elections to the respective funds,” said Blanchett. “Focusing on new ensures they – likely – had access to the ESG fund when allocating to the core menu and they selected that particular fund.” 

If the researchers instead included all participants, it’s possible the ESG funds may not have been available when the participant decided to self-direct their retirement plan investments, and possible that the funds were “mapped” into another investment the participant originally selected that was replaced with a fund change, he added.

New accounts selected for the research are likely to have lower dollar amounts as compared to older accounts, which Blanchett acknowledged.  

“Newer accounts are [almost] always always the smaller balances unless there is a rollover,” Blanchett said. “This effect is going to persist regardless of participant age. Younger individuals are more likely to change jobs [i.e., have shorter tenure] so they are going to be a higher portion of a group if we’re just focusing on new participants.”

Blanchett added that the study didn’t focus on young retirement plan participants, but instead individuals who had newly enrolled in the plan, who were more likely to be young.

“What this research doesn’t really tell us anything about is things like retirement preparedness or savings,” he added. “For example, some research has suggested participants are willing to save more when they have access to ESG funds.”

Data for the analysis was obtained from a top 10, by assets, recordkeeper of U.S. defined contribution plans, which a PGIM spokesperson did not name for privacy reasons. For the analysis, approximately 100,000 participants who are self-directing their accounts with less than one year of service were initially randomly selected across the entire available participant population. To be included in the dataset, the participant had to meet the following criteria:

  • Participants’ ages are between the ages of 20 and 80.

  • Years of plan participation (i.e., plan tenure) is two years or less.

  • The participant must be coded as actively participating in the plan.

  • The participant must have an income higher than $10,000.

  • The participant must have a balance greater than $1

Data was gathered by EBRI and PGIM, as an extract, in November 2021.

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