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Why you don’t (yet) have an ESG option in your 401(k)

Sometimes, all you have to do is ask. And ask again. And then, maybe, ask yet again.


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Sometimes, all you have to do is ask. And ask again. And then, maybe, ask yet again.

That’s what Maureen Kline, VP of public affairs and sustainability at the U.S. arm of Italy’s Pirelli Tire, did during her yearlong effort to get an ESG fund added to her company’s 401(k) plan. She started back in 2016, when sustainable investing was still considered a passing fad or niche strategy by much of the mainstream investment community.

"The first hurdle for me was understanding who was on the [retirement plan] committee and who to raise the issue with. And the answer to that second question is your HR department," Kline said.

Despite the challenges — including concerns among some about performance — she kept pushing, and in the third quarter of 2017, Pirelli added the Vanguard FTSE Social Index Admiral Fund to the 401(k) it offers its U.S. employees.

On its face, this may not seem like such a feat, but when you consider the numbers, it is.

ESG-managed investment funds represent 33 percent of the $51.4 trillion in U.S. assets under professional management, according to US SIF Foundation’s 2020 biennial "Report on US Sustainable and Impact Investing Trends." Meanwhile, as late as 2019, only about 3 percent of 401(k) plans included an ESG option, according to latest data available from the Plan Sponsor Council of America, and those investments accounted for just 0.1 percent of plan assets.

Why haven’t 401(k)s joined the ESG revolution? 3 main reasons — along with the reasons they’re no longer relevant.

The fiduciaries responsible for overseeing employer-sponsored plans — whether it’s the company’s board of trustees or a board-appointed committee — make crucial decisions, choosing 401(k) plan administrators, money manager(s) and investment funds for millions of American workers. It’s a huge responsibility, so some lag in ESG adoption among these plans seems reasonable. Still, the extent of the lag is shocking, especially given that research in recent years consistently has found that employees would like to have these options.

Most recently, a survey done by Schroders found that 90 percent of participants who knew of ESG-related options offered by their employer invested in them. And nearly 70 percent of participants who weren’t offered an ESG option, or weren’t sure, said they might contribute more to their 401(k) if one were available.

Statistics such as these beg the question: What gives? Why haven’t 401(k)s joined the ESG revolution? Here I’ll get into a few of the main reasons — along with the reasons they’re no longer relevant.

Regulatory roadblocks

Up until 2020, the U.S. Department of Labor generally took the position that fiduciaries could opt for ESG funds as long as the financial considerations were the same as those of other options. Still, 401(k) fiduciaries — and the ultra-cautious investment consultants who advise them — never have been anxious to make changes to a plan unless employees push for it, so progress has been slow.

Then, last year, it came to a halt with a new rule from the DoL under President Donald Trump. The rule said that fiduciaries could only consider investment factors such as risk and return, not ESG factors, when choosing 401(k) funds, and it explicitly disallowed employers from automatically enrolling workers into an ESG-focused fund.

This regulation was widely seen as having a chilling effect. "It would have frozen anyone [considering ESG options] in their tracks," said William Sisson, executive director of the North American arm of the World Business Council for Sustainable Development, a CEO-led organization of more than 200 companies, which has published two guides related to ESG and 401(k)s. "It didn’t prevent you from doing it, it just made it extremely challenging to the fiduciaries."

But a lot has changed in the last six months.

The Biden administration has said it would not enforce the Trump-era rules and would re-examine the need for them. Even more important, legislation before the House and Senate would formally overturn the 2020 rule and provide the legal certainty 401(k) fiduciaries need to feel comfortable adding these funds.

"We believe this legislation would essentially unlock the door for fiduciaries to finally and freely incorporate these ESG funds into their retirement asset programs," Sisson told me. "Because it basically creates the legal language that won’t allow regulatory disruptions in the future."

Fear of lawsuits

Another reason 401(k)s have lagged in ESG adoption is the perception that adding these options would open companies up to lawsuits. The number of lawsuits involving 401(k) investments, typically over allegedly high cost or underperformance, has ballooned in recent years. Is there any indication these lawsuits stem from ESG funds? No. It’s merely a perception of legal jeopardy by plan fiduciaries and their advisers, which has become increasingly difficult to maintain given the general outperformance of sustainable investment funds.

Many ESG funds have been around long enough o have track records, and they’ve been besting their traditional peers. In 2020, 72 percent of sustainable equity funds ranked in the top half of their categories, and all 26 ESG index funds studied outperformed their conventional peers. Moreover, the existence of these index funds should quell any worries about lawsuits based on fees, as passively managed fund cost less than those of their actively managed counterparts.

Target-date funds

Many employees feel more comfortable leaving investment decisions to the experts, or to a formula. Target-based funds choose participants’ investment mix for them according to the year they expect to retire, then shift the mix from stocks to bonds as investors approach retirement age. These all-in-one funds have become particularly popular with younger employees.

At year-end 2018, 62 percent of 401(k) participants in their 20s held target date funds, compared with half of 401(k) participants in their 60s.

Only a few money managers — including Natixis and BlackRock — offer an ESG-focused target-date fund. An increase in their availability essentially would be the final piece of the puzzle, but with the changes already taking place, there’s never been a better time to ask for the addition of an ESG option to your 401(k).

In fact, speaking up may be all it takes.

Because the people responsible for overseeing these plans are "not thinking about ESG in their daily functions," Sisson said. "Somebody’s got to come knock on their door, like Maureen Kline, and say, ‘We’re an ESG leading company; why aren’t we incorporating ESG funds into our portfolios?’ And then the lightbulbs go off."

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