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next issue no. 5: Participant engagement
Responsible investing: regulatory attention is heating up, but so is investor appetite
Contrary to popular belief, Nuveen’s latest research reveals that increased focus on clicktivism, conscientious consumerism and corporate mischiefs are NOT keys to driving the demand for responsible investing (RI).
RI has seen a remarkable rise in market penetration over the past several years: In 2019, U.S. investors poured $21.4 billion into funds focused on environmental, social and governance (ESG) themes, with another $20.9 billion flowing into such funds in the first six months of 2020 alone, according to Morningstar. To put this into context, from 2009 to 2016, fund flows were consistently below $5 billion annually, and in 2017 and 2018, they barely broke the $5 billion mark.1 However, U.S. DC plans are one of the few areas of the investment universe not contributing to this growth. According to the Plan Sponsor Council of America, only about 3% of 401(k) plans offer an ESG-themed option on the investment menu.
With such investor enthusiasm, why has there has been little uptake of ESG-themed investments in 401(k) plans? The reasons behind this disconnect are a confusing combination of misconceptions of what responsible investment is, what’s driving the continued demand and decades of mixed messaging from the U.S. Department of Labor (DOL).
Lack of common understanding yields misconception
There is good explanation for lack of a consistent understanding about what RI is, and what it is not. Our industry has had no shortage of its own terminology over the years and as an area of growth, there continue to be new entrants to the space, bringing with them their own labeling and RI phrases.
- Sustainable finance
- Business ethics
- Program-related investing
- Mission-related investing
- Place-based investing
- Impact investing
- Triple bottom line
77% of Americans want to work for an employer that makes a positive social and environmental impact
Investor’s perceptions have evolved
Many assume that the general populations’ increased awareness of and engagement in environmental and social issues is what’s driving the increasing demand and prevalence of responsible investing capabilities. However, for the first time, Nuveen’s Fifth Annual Responsible Investing Survey finds that the prospect of better performance is top-of-mind for investors considering RI strategies. The majority of investors (53%) cited performance as their main motivation for investing in RI. Alignment with investors’ values and better risk management were the second and third motivations, respectively. Given that two of the top three reasons investors give for participating in responsible investing are investment related is telling, and indicates to us that investors are evolving their understanding of the responsible investing opportunity and disputing the myth that responsible investing yields trailing performance.
53% of investors cited performance as their main motivation for investing in RI
Additionally, our research shows that RI has the potential to enhance financial performance over a longer term. Figure 1 shows that the long-term performance of the MSCI KLD 400 Social Index, a leading RI stock index, is comparable to two broad market indexes, the S&P 500 and Russell 3000.
Employees’ interest is on the rise
The interest in responsible investing extends beyond a sole investor’s perspective and broadens when discussed in the context of employee/employer relations, showing signs of influencing attitudes about the workplace.
Nuveen’s research suggests that a company’s social and environmental impact is not only becoming an increasingly important factor to employees, but many are drawn to companies that offer RI in their retirement plans.
In fact, our survey found that 77% of Americans want to work for an employer that makes a positive social and environmental impact.
Our survey also found that having responsible investment options on the retirement menu can provide benefits to both plan sponsors and participants alike.
Responsible investing (RI) is an investment approach that incorporates Environmental, Social and Governance (ESG) factors into investment analysis, portfolio construction and ongoing monitoring across asset classes with the objective of enhancing long-term performance, managing risk and creating opportunity.
Employees want to work for a company that makes a positive social and environmental impact, they also want it as an investment option in their retirement plan and would choose an employer accordingly. Our survey found that the majority of investors (59%) would choose an employer based on the availability of having a responsible investment option in their retirement plan.
Having an RI option on the retirement menu promotes positive attitudes toward plan sponsors, as more than 3 in 4 investors (76%) say employers who include such options care about their employees’ retirement outcomes. Having an RI option also promotes good feelings (76%) and loyalty (66%) about working for an employer. Companies have always had an important role to play in society, but in the current environment, the way employers treat their employees has become increasingly important.
Having RI options on the plan menu can potentially boost participation, which could lead to increased retirement savings. The majority (72%) of investors in our survey say they feel better contributing to a workplace retirement plan when it has RI on the plan menu. In fact, more than half of the investors we surveyed (54%) said they would invest their entire retirement balance in a responsible investment portfolio. This is especially true for millennials, 80% of whom said they would invest their entire balance in an RI option if given the choice. These findings demonstrate that participant demand exists, and that people are taking action to invest in such strategies when given access to them. This is particularly relevant for younger employees who often need encouragement to start saving.
Signals are coming in loud and…mixed
While investors seem to increasingly understand the performance opportunity and employers may enjoy the ancillary benefits beyond performance like employee engagement, the DOL appears…capricious. It first issued guidance on the subject nearly 30 years ago, under the Clinton administration. Since then, and through several presidential administrations, there has been a regulatory see-saw of guidance, with some administrations supporting ESG in DC plans and others adopting a more restrictive stance.
We’ve seen three directives during the current President Trump administration. The latest guidance issued in a June 2020 proposal maintains that plan fiduciaries only consider financial factors when selecting investment options, and avoid taking on additional investment risk to promote goals unrelated to the financial interests of plan participants. The proposal doesn’t outright ban ESG funds in DC plans, but it does require plan sponsors to provide more extensive documentation and benchmarks to justify including them on the menu.
The industry responded
In the 30-day comment period that followed the DOL’s proposal, the DOL received over 8,500 comments on its website. More than 95% of those comments opposed the DOL’s proposed rulemaking. Only 4% of comments expressed support, and 1% expressed neutral views or recommended changes without clearly expressing support or opposition. Public comments were overwhelmingly opposed across individuals, investment-related groups, and non-investment-related groups, including Nuveen’s, and those of our parent company, TIAA.
Fundamentally, we believe that the DOL’s proposed rule mistakenly characterizes ESG investments as subordinating risk and return to “non-pecuniary” or nonfinancial objectives. To the contrary, we argue that the facts, data and statistics demonstrate that ESG investing is “pecuniary” and can be in the best interests of participants, because ESG factors directly align with pecuniary considerations and are aimed at increasing competitive risk-adjusted returns. Furthermore, failure to consider the appropriate role of ESG investments or factors could in certain circumstances be counter to the pecuniary interests of participants. US SIF: The Forum for Sustainable and Responsible Investing also supported this viewpoint in its comment letter.
There is growing consensus that ESG considerations are financially material to investment decisions. Asset managers are increasingly integrating ESG factors into their traditional financial analysis, across conventional investment options. According to a Harvard survey from 2018, 80% of asset managers now consider ESG factors when making investment decisions, citing client demand, and the belief that ESG factors are material to investment performance.2 Indeed, the ability for plan sponsors to continue to use ESG factors when constructing a lineup aligns with the DOL’s existing guidance. There is also substantial research demonstrating that ESG investments offer risk-adjusted returns competitive with traditional funds. One such study, published by the CFA Institute, showed that over a 10-year period an S&P 500 portfolio composed of companies that performed well on ESG factors generated lower risk and greater annualized returns than a portfolio comprising companies that performed poorly on ESG factors.3
We also believe that the existing framework of fiduciary duties of prudence and loyalty already provides ample safeguards for ESG investments, and potential investments that incorporate ESG factors should not be singled out for special scrutiny. At this point, it is important for plan sponsors to understand this is not yet a rule. It is a proposed regulation, and there will likely be a lengthy process before it is finalized, and it is subject to change.
Navigating next steps
RI is an established philosophy that has been around for decades and has been moving into the mainstream. Now, in the wake of the coronavirus crisis, RI has garnered even more attention: Companies with strong ESG practices have shown resiliency and the ability to weather periods of volatility, making them well positioned for successful long-term financial performance, and a natural fit for the long time horizon required to save for retirement.
As we await a final ruling from the DOL, plan sponsors considering adding an RI option to the plan menu should make sure to do the following, as part of their fiduciary responsibilities:
- Update the investment policy statement (IPS) to reflect any changes to the plan’s investing criteria.
- Ensure any RI options selected adhere to the policies set forth in the IPS (such as reasonable fees, diversification, management and track record).
- Provide additional participant communication and education about RI options.
- Develop a list of standards for evaluating RI investments that aligns with the IPS.
1 Morningstar, Sustainable Funds Continue to Rake in Assets During the Second Quarter, 30 Jun 2020.
2 Amel-Zadeh, A., & Serafeim, G. 2018. “Why and How Investors Use ESG Information: Evidence from a Global Survey.” Financial Analysts Journal, Vol. 74, No. 3 (Third Quarter).
3 ESG Investing: Can You Have Your Cake and Eat It Too?, Dhingra, Gautam, Olson, Christopher, 3 Sep 2019.
MSCI KLD 400 Social Index is a capitalization weighted index of 400 US securities that provides exposure to companies with outstanding Environmental, Social and Governance (ESG) ratings and excludes companies whose products have negative social or environmental impacts.
Russell 3000 ® Index measures the performance of the stocks of the 3,000 largest publicly traded U.S. companies, based on market capitalization.
S&P 500 ® Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy.
The views and opinions expressed are for informational and educational purposes only as of the date of production/writing and may change without notice at any time based on numerous factors, such as market or other conditions, legal and regulatory developments, additional risks and uncertainties and may not come to pass. This material may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections, forecasts, estimates of market returns, and proposed or expected portfolio composition. Any changes to assumptions that may have been made in preparing this material could have a material impact on the information presented herein by way of example. Past performance is no guarantee of future results. Investing involves risk; principal loss is possible.
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