US SIF Lays Out Steps for Plan Sponsors to Consider Before Adding ESG Investments

The guide also explains how plan advisers can help employers add sustainable funds to their lineups. 

The US SIF Foundation has launched a step-by-step guide for defined contribution (DC) plan sponsors interested in sustainability and, in doing so, called upon third parties to help employers implement environmental, social and governance (ESG) funds.

Over the past few years, the finance and retirement industries have placed an increased focus on sustainability, and especially environmental, social and governance (ESG) funds. As stated in US SIF’s guide, a 2019 Morningstar report found 72% of surveyed adults had at least a moderate interest in sustainable investing, and 21% said they could be classified as “sustainability-driven.”

Another report by Natixis Global Asset Management found 75% of the 1,000 U.S. employees surveyed said they believed it is “important to make the world a better place while growing their wealth,” and 61% said including sustainable funds would increase their likelihood of contributing to a retirement plan. 

However, US SIF says plan sponsors of private-sector DC retirement plans are just now beginning to meet the demand for sustainable funds. A 2020 analysis for the US SIF Foundation by ISS Market Intelligence’s BrightScope platform of 58,590 401(k) plans found that only 11,488 participants—or fewer than one-fifth—had assets in funds that BrightScope considered “socially conscious.”

Other surveys find that many employers are still concerned about risking their fiduciary status, should they decide to add ESG options into their retirement plans.

With these facts in mind, US SIF suggests that as a first step, employers should increase their knowledge of sustainable investing and related performance and fiduciary questions.

Addressing the issue of fiduciary duty, the analysis highlights a 2005 study by law firm Freshfields Bruckhaus Deringer which examined fiduciary law in nine developed markets, including the United States, and found that the links between ESG factors and financial performance are increasingly being recognized. On that basis, integrating ESG considerations into an investment analysis so as to more reliably predict financial performance is clearly permissible and is arguably required in all jurisdictions.

A 2020 follow-up report to the Freshfields study, which included interviews with policymakers, lawyers and senior investment professionals, states that “the integration of ESG issues into investment practice and decisionmaking is an increasingly standard part of the regulatory and legal requirements for institutional investors, along with requirements to consider the sustainability-related preferences of their clients and beneficiaries, and to report on how these obligations have been implemented.”

The next step in the guide to implementing ESG investments is gauging participants’ interests. US SIF recommends employers survey their plan participants on the matter. Employers can also include explanatory information about sustainable investing at the beginning of each survey to clear up any confusion. The survey could ask whether participants are satisfied with their retirement fund options, what changes or improvements they would like to see in their retirement plan, any issues they would like the fund manager to address, etc.

The third step is to discuss implementation with a consultant and/or a plan administrator. Additionally, US SIF says it is prudent for plan sponsors to research any existing plan administrator platform and external advisers, as they may have information about sustainable funds.

When working with a consultant, US SIF recommends plan sponsors ask the following questions: What is your level of knowledge and experience with sustainable investing? What is your view of sustainable funds as part of a DC lineup? Have you conducted successful sustainable investing searches for DC plans?

Plan sponsors should also inquire if there are significant fees and/or administrative issues associated with adding a new fund to the investment lineup.

Advisers who work with plan sponsors should also have a “clearly articulated plan and method for adding a sustainable fund with appropriate due diligence,” as US SIF says this is key to supporting the plan’s fiduciary duty. External consultants and advisers can also assist with procedural and reporting aspects of the process, especially as more consultants are developing expertise in sustainable investing, US SIF writes.

As a fourth step, the guide says plan sponsors must choose a fund or funds and monitor performance. Among the list of possible sustainable investment funds are domestic equity funds, exchange-traded funds (ETFs), passively managed funds, lifestyle funds and target-date funds (TDFs).

Evaluating the retirement plan and its participants can help sponsors narrow their list of fund candidates. For example, US SIF asks employers to question whether participants have specific values or beliefs that will affect their choice of a sustainable fund.

When monitoring sustainable funds, US SIF says to ask the investment fund manager or consultant, when evaluating the fund’s financial performance, to include whether the fund is meeting return expectations, net of fees, in relation to its benchmark and peers; if the fund is maintaining its stated investment style, including its sustainability approach; and whether the fund manager’s fees are reasonable when compared with the fund’s peer group.

Lastly, step five is to educate participants about ESG investments and the employer’s decision. US SIF says plan sponsors should ask themselves whether the information provided to participants enables them to compare a sustainable fund with a non-sustainable fund based on financial performance and fees; whether the information explains specific ESG criteria the fund uses; if the information explains active ownership aspects of the fund; and more.

US SIF says plan administrators, sustainable fund managers and/or consultants should be able to provide information about sustainable funds within the lineup.

More information and resources from the US SIF Foundation’s guide can be found here.

*BrightScope is an ISS Market Intelligence business and is part of Institutional Shareholder Services (ISS), which owns and operates PLANSPONSOR and PLANADVISER.