PLANSPONSOR - February/March 2020 - 35

INVESTMENT FOCUS
Investment Selection
But there is a break in the logic when it
comes to actual selection of investment
options. While about half of DC plan
participants say they would prefer to invest
in responsible companies, just 18% of
sponsors rate ESG factors as important in
choosing options and give greater weight
to fund performance, cost and style.
That is understandable, though, as
Department of Labor (DOL) guidance
requires that ESG policies not constrain
investment returns. Field Assistance
Bulletin (FAB) No. 2018-01 says
Employee Retirement Income Security
Act (ERISA) fiduciaries must always
put first the economic interests of the
plan in providing retirement benefits.
Accordingly, uptake of ESG-designated
options in DC plans has been slow. In
its " 2019 How America Saves " study,
Vanguard Group reports that 23% of DC
participants are offered a social fund
option, but just 4% invest in it. In another
Cerulli survey, from 2019, only a quarter
of advisers expected DC plan clients to
increase allocations to socially aligned
options in the coming year.
When a sponsor decides the time is
right to align its plan with ESG principles,
many implementation opportunities can
pass muster with current regulations and
fiduciary standards, says Marla Kreindler,
veteran ERISA attorney and partner in the
Chicago office of global law firm Morgan,
Lewis & Bockius. She lists-in addition
to adding a new dedicated ESG offering-
reviewing the principles on which proxies
are voted, examining the ESG content of
the funds already in the plan, making
ESG part of a plan's custom fund design,
and ensuring that ESG funds are available
through a plan's brokerage window.
Even for funds that are dedicated
ESG portfolios, the application of principles
can vary. " Some managers are very
restrictive on ESG guidelines, and some
allow their portfolio managers discretion
in building ESG into the portfolio, " says
Patrick Morrell, senior investment analyst
at advisory firm SS/RBA in Pearl River,
New York. " A manager might talk about
its rosy view of the world but then include
big fossil fuel producers in the portfolio,
or banks that lend heavily to resources
companies. Therefore, a sponsor needs to
know what the fund is trying to invest in
favor of and then what it might want to
exclude, " Morrell explains.
Depending on philosophy, a plan
may have been investing in ESG without
realizing it and not need an additional
fund. " Many of the ESG funds that sponsors
have asked us to look at have turned
out to earn lower ESG scores than the
non-dedicated ESG funds they already
have in their menus, " notes Ed McIlveen,
research director at Francis Investment
Counsel, in Brookfield, Wisconsin. " When
clients started seeing that, they saw that
their current managers were willing to
adapt their processes to ESG and what they
already had wasn't harming them. "
Rating funds for their ESG qualifications
draws in another current of
complexity. Evaluations are available
from a number of established sources,
but their conclusions might be at odds
with one another. Research Affiliates, an
investment manager in Newport Beach,
California, recently published " What
a Difference an ESG Ratings Provider
Makes!, " a thoughtful study of rating
methodologies. " Investors ... must ensure
the approach taken by the ratings provider
they rely on is consistent with their ESG
preferences or they risk constructing
portfolios that do not align with their
ESG views, " the paper concludes, adding
this insight: " ESG portfolios constructed
using the ratings of two well-known ESG
ratings providers yield large performance
dispersion and low correlation of returns. "
Targeted Communications
Whether a sponsor chooses to add an ESG
fund or rely on what is in place, the nuances
of ESG call for targeted communications.
" It has to start with sponsors saying how
they pick managers and how the process
goes beyond performance-the stability
While about
half of DC plan
participants
say they would
prefer to invest
in responsible
companies, just
18% of sponsors
rate ESG factors
as important in
choosing options.
of managers' teams, the consistency of
their investment processes, and how they
incorporate ESG, " says Hayden Gallary,
managing director at Boston-based investment
firm Cambridge Associates.
" And then, rather than sending
participants a fund fact sheet of boilerplate
from the recordkeeper, " Gallary
advises, " the committee should reach
out with a discussion of its own, saying
what changes it has made to the plan and
how it arrived at them. When a communication
comes directly from the sponsor,
participants will give it greater attention. "
To reiterate, investments chosen for
their ESG content need to clear the bar of
returns, as well. " We don't give leeway to
funds just because this is a new endeavor
for the retirement industry, " notes
Morrell. " We want to see a sustainable
pattern of investment skill at ESG. Funds
that have been out there for just three or
four years are on our radar, but we're not
going to propose them to sponsor clients.
" ESG is going to be part of every
manager's investment process, " he adds.
" Today it's still emerging. Greater adoption
will take five or 10 years, and investment
managers will have to commit to that. "
-John Keefe
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