Roughly three-quarters of 401(k) participants say they would participate more in their plans if they had access to ESG investment options.
That, according to a recent survey by Schroders, was the case for 74% of people, up from 69% in a similar survey last year — a result hinting at strong and growing interest, and potentially demand, for ESG options in defined contribution plans.
The problem, though, is that the 401(k) system is hardly ready to meet much demand for ESG.
“We have done this two years in a row and gotten similar results both times,” said Marina Severinovsky, head of sustainability for North America at Schroders. “At least knowing that there is some potential — there is some fertile ground for [ESG] — is interesting.”
Currently, few 401(k) plans include any kind of ESG investment option, and those that do often have low pickup rates for ESG investments among retirement savers. Less than 5% of 401(k)s had ESG funds on their menus in 2020, according to a recent report from the Plan Sponsor Council of America. About a tenth of all 401(k) participants invested in ESG funds, representing just 0.03% of plan assets, PSCA found.
When asked why their plans don’t include ESG options, plan sponsors said they just hadn’t considered it (59%), cited unclear regulatory requirements (26%) or noted a lack of interest from participants (29%), among other reasons, according to PSCA.
The industry is still very much at the beginning of integrating ESG in DC plans, Severinovsky said. And to the extent that survey results don’t match with how often people opt for ESG funds in their retirement plans, part of the reason can be chalked up to virtue signaling, she said.
Eighty-seven percent of the 1,000 people surveyed in February said they feel that their investments should align with their values, according to Schroders. Further, 78% said they thought socially responsible companies will have stronger performance over time than peers.
The survey included respondents age 45 to 75, and a total of 317 indicated they had DC plans. Of those whose employer-sponsored retirement plans included ESG options, about 90% said they invested in those funds, and 73% said they allocate at least half of their plan assets to those options, according to Schroders.
The most important issues for ESG, the respondents indicated, are living wages (51%), climate (39%), human rights (36%), biodiversity (30%), and diversity and inclusion (22%), the survey found.
Vestwell’s experience offering ESG within 401(k)s shows that people aren’t necessarily quick to opt for it. The firm added an ESG option in its managed accounts for 401(k) clients about six months ago, CEO Aaron Schumm said.
“Personally, I’m a big advocate for ESG,” he said. “What we’ve seen is less actual participation in it than we would have thought. There is still data that we are trying to pull from this to understand why.”
Industrywide, there are some anecdotal reasons explaining why ESG is slow to move in 401(k)s, Schumm said. “Folks who want ESG products want them really clean, and I think the screening process for ESG is not quite there yet.”
ESG appears to be less popular with older retirement savers, and it can a polarizing topic, he said. And those who like the idea of ESG but aren’t overly enthusiastic are generally not motivated enough to invest outside of a plan’s default option.
Vestwell, which includes several state-run automatic IRAs in its book of business, has raised the topic of including ESG in those programs.
“We’ve started to have conversations with the states and their interest in it,” Schumm said. “There is definitely openness to it.”
Another firm, Morningstar, is planning an ESG pooled employer plan, which could launch after the Department of Labor issues its final rule on ESG investments in retirement plans. Current regulations that were put in place at the end of the Trump administration, although not enforced, have been seen as having a chilling effect on ESG in 401(k)s. Those rules also specifically call out the qualified default investment options in plans, usually target-date funds, and all but prohibit them from being ESG investments.
Last month, Morningstar published a report on the 401(k) market that found assets have mostly been invested in funds with average-to-high ESG risk. According to that paper, 4% of investment options in 401(k)s, representing 2% of assets, are in strategies that have the lowest ESG risk levels, compared with 10% of all Morningstar-rated strategies that fall into that category.
“We’re able to identify almost $3 trillion in assets in 401(k) plans, and most of them we don’t see skewed toward 4- or 5-globe funds,” said Aron Szapiro, head of retirement studies and public policy at Morningstar Investment Management, referring to the company’s sustainability ratings.
The ESG fund flows within 401(k)s are dramatically different from those outside of it, he noted.
“If the [DOL] final regulation looks close to what they proposed last fall, you will see pretty quickly more plan sponsors offering different kinds of strategies that consider E, S and G information,” Szapiro said.
Schroders has developed a participant-portal app that’s currently being beta-tested outside of the US. The app will let participants see the positive impact their investments are having, Severinovsky said.
That app, along with a wider ESG offering from Schroders, could become available after the DOL issues its final ESG rule, she said.
For the industry, “what is needed is a whole set of offerings that basically wrap around the participant and also the sponsor — to protect the sponsor but also to engage the participant,” she said.
The first step in that could include integrating ESG principles into a plan broadly, while the second step could be adding branded funds that are labeled as ESG, Severinovsky said.
The industry should help provide education for both plan sponsors and participants through content that Is both informational and entertaining, she said. Product and plan providers should also help gauge interest in ESG, as that can vary by a company’s geography and industry, she noted.
Participants, for example, need to be shown through ongoing reporting that there are good reasons, such as risk-adjusted returns, that justify their ESG investments, she said.
“You’re still making the decisions on what’s best for your plan participants from a pecuniary standpoint,” Severinovsky said. “As a plan sponsor, you don’t want to get sued, and [you want to] do right by your plan participants.”
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