Ed Farrington, Executive Vice President, Institutional and Retirement, for Natixis Investment Managers, discusses ESG investing, at the virtual 2020 PLANADVISER National Conference.
PLANADVISER: How long has the acronym ESG [environmental, social, governance] meant something to the retirement-plan adviser community? Earlier, the terminology was SRI, socially responsible investing. And you also hear “economically targeted investments.” Is ESG well-defined at this point?ED FARRINGTON: This summer, the Department of Labor [DOL] issued a proposal that is material and spends a fair amount of time trying to define how we can, in fact, go through the process of integrating ESG into a defined contribution [DC] plan.
By evidence of that proposal, the answer is, it’s not that well-defined. And maybe that’s what we have to grow through right now: more clearly defining ESG. For about five years now, we’ve been advocating for the expansion of ESG strategies inside defined contribution plans—including, three-and-a-half years ago, launching a target-date range where all of the underlying strategies integrate ESG into the investment process.
Whether or not to take such steps is now a commonplace conversation, driven by both demand and a growing body of evidence that ESG criteria can help investors become better investors.
For any defined contribution plan, it’s important to begin with knowing there are two paths. One attracts investors who are trying to make a better world. The second attracts investors who are just trying to become better investors. When it comes to the sponsor of a DC plan, it’s important to start down the road of better investing, not better world.
You might wind up influencing, and improving, the world. But it’s key to start with creating better economic outcomes for participants, because they’re already engaged in a social benefit in a defined contribution plan.
If ESG investing is about creating economic value, that’s in line with the duties of a plan sponsor or an investment committee member.
PA: Can ESG can be a normal part of a fund that’s seeking the best returns possible, or is it an add-on?
FARRINGTON: If you looked at the underlying components of our target-date range, we have both intentional ESG investors and ESG integration managers who you wouldn’t say are intentional ESG managers. But we mix the two together because of this focus on economic outcome.
The duty of the sponsor is to not constrain yourself to only ESG managers in the search. Find out what the process is behind every manager, and you might find there are some that don’t confine themselves to ESG but index quite high when it comes to using ESG criteria. Some of them—particularly the high-conviction active ones—will actually create alpha, as well. You might be able to satisfy that inclusion in the plan menu without having to call it sustainable, responsible ESG. You might just find [ESG]’s a really important part of the investment process of something you already know, like and trust.
PA: What is the demand for this in the marketplace?
FARRINGTON: We know there’s increasing demand, from a participant level, for these types of strategies. Certainly, there’s broad demand for more options in this space, but specifically from the Millennial generation.
By the year 2025, 75% of the workforce will be Millennial. That means 75% of our participants. And we also know from our DC plan participant survey that six in ten participants say they would like to see more socially responsible investments in their plan offering.
So now the question is, what process do you undertake, as a plan sponsor, to get to that place? What role can advisers play? There’s a massive opportunity for us who serve the plan sponsor community to become expert in this topic, because plan sponsors need someone to take them on this journey and help them avoid things that could cause them real pain going forward.
Maybe that means having an accreditation that says, “I can help you on this—I can help you through this process of adding these investments” and then keeping them on that road of economically viable strategies. The next step is to be that person who can educate both the sponsor and the participant as to what this is and what it’s not. And this demand is not going away.
But neither is the regulatory environment that says, “We’ve got to help people have the biggest balance possible for the risk they’re willing to take over the next 10, 20, 30, 40 years.” Marrying those two is one of the great opportunities of our lifetime for those of us in this space.
PA: Is there a difference in ESG depending on the type of fund, such as equities versus fixed income?
FARRINGTON: For Natixis, in deciding to have a target-date range that integrates ESG, you obviously have to have both equity and fixed income. To me, ultimately, the way to think about this is risk management. That shows up whether the issuer is on the equity side or the debt side.
We’re all seeing increasing evidence, from a credit-rating standpoint, that these are material issues. You can find guidance through places like SASB [Sustainability Accounting Standards Board], which will help you map what factors are material for different industries and, therefore, for different issuers underneath those industries when it comes to their financial performance. So there’s absolutely a way to integrate ESG criteria into your fixed-income portfolios.
I’m not trying to mention only our own affiliates. I’m only mentioning them because that’s the experience I live, day to day. Loomis Sayles, which is one of the larger fixed-income shops on the planet, and certainly has a strong history and credit analysis—integrates ESG in its processes. It manages ESG-specific portfolios. But if you ask people there, they’ll say they’re integrating that data in all of their portfolios. They have pointed ahead of ESG for the firm several years ago. It’s just part of the firm’s DNA when it comes to credit analysis.
So it’s present on both sides. As this space evolves and innovation occurs in ESG integration and research, and as using ESG factors can be linked to material financial outcomes for all funds, we shouldn’t constrain plan sponsors from considering that. We should encourage it.