By virtually any measure, the demand for socially conscious investment products has never been greater. Thanks in large part to support from women and young investors, investment strategies that focus on environmental, social and governance issues reached $12 trillion last year
according to US SIF. That's a quarter of all U.S. assets under professional management going into ESG.
Yet when it comes to the primary way in which younger generations invest, through company-sponsored retirement savings plans, their desire to match their investments and values is falling on deaf ears.
(More: Why millennial demand for ESG is falling on deaf ears)
The exact numbers are difficult to pinpoint, and some progress is being made, but most calculations estimate that less than 8% of company-sponsored retirement plans include even a single ESG fund option on the investment menu. This is despite data such as
a Natixis survey showing that 74% of plan participants want access to ESG funds in their retirement savings plan.
Attractive benefits
But that is likely to change as the unemployment rate drops and employers seek to differentiate themselves with attractive benefits programs, said Steve Ulian, head of sales and relationship management at Bank of America.
"If you're going to attract talent, you will need to add ESG funds on your retirement plan menu, because people are choosing their employers now based on [benefit programs] to a fairly significant degree," he said.
However, Mr. Ulian admits that Bank of America didn't add the first ESG fund to its plan menu until last year.
When it comes to availability in retirement plans, the momentum ESG investing is experiencing is often lost in a fog of regulatory and legal uncertainty, with a bit of misperception mixed in, too.
(More: 529 plans also miss the boat when it comes to ESG)
The first roadblock that keeps ESG funds from finding their way onto retirement plan menus involves plan sponsors bending over backward to avoid violating their fiduciary duties while operating under the often vague guidance from the Department of Labor's interpretations of the Employee Retirement Income Security Act of 1974.
"The whole retirement-plan industry is very lawsuit-averse, so if you're trying to deliver some outside nonfinancial benefit, it may not be within the fiduciary boundaries that a plan sponsor has to stay within," said Jon Hale, head of sustainable investing research at Morningstar.
Confusing guidance
The DOL "has been somewhat ambiguous," Mr. Hale said, citing guidance from the DOL in April 2018 that some think complicated DOL guidance issued in October 2015. The earlier guidance essentially said including ESG considerations when adding funds to a plan was squarely within the boundaries of fiduciary duty. But the more recent guidance said the screening of funds needs to be consistent for ESG and non-ESG funds — and that muddies the waters to some.
"At some companies, ESG is a foreign language that no one understands."
Rob Thomas, President Social(K)
Some interpreted the two sets of guidance as political, considering that one came under President Barack Obama and the other under President Donald J. Trump.
But Pete Swisher, senior vice president at the retirement planning and fiduciary outsourcing firm Pentegra, described the guidance as a "very consistent pattern of long-term interpretations of ERISA by career DOL employees."
"The 2018 guidance was just to clarify that it wasn't a free pass for ESG funds, and that the evaluations of funds included in plans need to be consistent," Mr. Swisher said.
That means that it's OK to have funds using ESG principles as long as the fund-screening process is driven by uniform financial criteria, he said.
Cost, performance
Issues of cost and overall performance — or perceptions about these — also limit the ESG choices employees ultimately find in their 401(k) investment lineups.
For decades, ESG funds have been considered expensive, which causes a drag on performance, and which by itself is a factor that could keep many ESG funds off retirement plan menus.
But these days, even though the 870 ESG funds tracked by Lipper are overshadowed by the more than 23,000 non-ESG funds, many of the ESG strategies are holding their own in terms of both performance and fees.
While it's not a perfect comparison to measure the performance of ESG funds against a much more diverse group that is more than 26 times larger, the Lipper data show the five-year average return of ESG equity funds through 2018 was 3.92%, which was exactly what non-ESG equity funds averaged over that period.
For bond funds over the same period, ESG funds averaged 2.22%, while their non-ESG counterparts averaged 2.32%.
In the mixed-asset fund category, ESG funds averaged 3.59%, while non-ESG funds averaged 3.36%.
In terms of fees, the expense ratios of ESG equity funds average 1.03%, which compares to 1.12% for non-ESG equity funds, according to Lipper. For bond funds, ESG funds average 74 basis points, compared to 86 basis points for non-ESG funds, and for mixed-asset funds the average expense ratios were equal for ESG and non-ESG funds.
"In order to have competitive returns, the ESG providers know they have to maintain lower average expense ratios," said Tom Roseen, Lipper's head of research services.
However, a large part of the adviser community still thinks ESG underperforms, experts said.
Mitchell Kraus, a partner at the advisory firm Capital Intelligence Associates, has made socially conscious investing a trademark of his financial planning. He said across industries, too many business owners are stuck in an old-school mentality that ESG funds underperform and therefore set the company up for a potential lawsuit from employees.
"Lots of businesses are owned by old white men who don't understand the appeal of ESG investments by younger people and women," he said. "Employees need to let their employer know this is important to them."
Mr. Kraus said that for the 10 401(k) plans that he manages, he brings up ESG funds during every investment review and "slowly but surely" is seeing companies adding ESG options.
"I drive an electric car, I have solar panels on my house and I bring up ESG investing with all my clients," Mr. Kraus said. "It's the fastest-growing part of my business."
However, other advisers have found clients aren't as willing to put their money behind their social or environmental beliefs.
"We started developing our own ESG asset allocation portfolio about four years ago, thinking we had at least a handful of clients that would really embrace it," said Robert Alexandrovic, director of client services at Tedstrom Wealth Advisors. "Even some of the clients that we thought would be a slam dunk have pushed back."
Mr. Alexandrovic said he rarely sees ESG funds offered on clients' retirement plan menus, and if he does, it's just one or two funds.
"You can't build a diversified portfolio with two funds," he said.
Another sticking point is found at companies where the person charged with building out the plan options is often not up for the job, said Rob Thomas, president of Social(K), a private-label 401(k) record-keeping platform focused on ESG investing.
"I can't tell you the number of people who run companies promoting sustainability and community commitment and environmental causes and blah blah blah, and their retirement plan offers Vanguard funds," Mr. Thomas said. "At some companies, ESG is a foreign language that no one understands, in a department where they're supposed to get it. Even people who get it don't want to do the extra work to add investment options because 401(k) money is very sticky, so people don't want to touch the plan."
New plans
Mr. Thomas said the growth he sees in ESG investing largely comes from the startup of new retirement plans.
Peter Lazaroff, co-chief investment officer at Plancorp, said he has seen similar apathy when it comes to making the effort to step outside the comfort zone and push for some ESG investment options.
"We always see an appetite for learning about ESG investing, but we see very few plans that demand ESG funds," he said. "The goals of a plan sponsor are to make it easy and inexpensive. If you're a plan sponsor and nobody is clamoring for ESG funds, adding another fund just adds confusion."
Anthony Eames, director of responsible investment strategy at Eaton Vance, said there's still a lot of education needed around ESG investing.
"If you think about how retirement plans come together, involving the senior management of a company and an adviser or consultant, they might not have the most current information on ESG investing," Mr. Eames said. "But we do know through our research that when ESG funds are added to the plan, the participants' view of their employer improves. As a result, the employee is more likely to recommend the company as a good place to work, and it also increases the participation rate of the retirement plan."
