A proposed regulation regarding the inclusion of environmental, social, and governance (ESG) factors into retirement plan investment decisions is expected to be finalized later this year.
Issued by the U.S. Department of Labor (DOL) on October 13, 2021, the proposal seeks to recognize the important role ESG investing can play in the evaluation and management of plan investments while continuing to uphold fundamental fiduciary obligations. It still requires that investments be made in the financial best interest of plan participants, but the proposal specifically states that the evaluation of an investment’s risk/return characteristics (the financial factors) may often require a consideration of the economic effects of climate change and other ESG factors. That is, it supports the inclusion of ESG as a financial factor—and suggests it’s a risk not to.
Fiduciaries who plan to implement an ESG strategy must continue to follow a diligent and documented process while ensuring decisions are made in the best interests of participants. These practices are long-standing and universal.
But what about the more complex circumstances a fiduciary may face when considering ESG options, including replacing an existing non-ESG investment option with an ESG option or designating an ESG option as the plan’s qualified default investment alternative (QDIA)?
Considerations regarding ESG investments
From the foundational to the most complicated, there is a range of decisions and strategies for plan sponsors to consider regarding ESG investments and their retirement plans.
The DOL guidance has reframed ESG-related risks as financial risks to organizations and investments in those organizations rather than merely considering them as distinctly environmental/social issues. Mitigating these risks is a critical part of an investment strategy, and it is important to evaluate and understand these risks in all products within a retirement plan.
Reframing the discussion from “ESG products” to “ESG considerations” of all investment products can help plan sponsors integrate their best thinking throughout the lineup, rather than creating separate processes for different types of investment vehicles.
To help support many of the inquiries we receive from plan sponsors and their advisors, we are pleased to issue this framework. It joins Evaluating ESG Funds in Light of New Guidance: A Fiduciary’s Guide as resources to help sponsors navigate the fiduciary landscape related to their consideration of ESG options.
Notes:
- All investing is subject to risk, including the possible loss of the money you invest.
- Diversification does not ensure a profit or protect against a loss.
- ESG funds are subject to ESG investment risk, which is the chance that the stocks or bonds screened by the index provider for ESG criteria generally will underperform the market as a whole or, in the aggregate, will trail returns of other funds screened for ESG criteria. The index provider’s assessment of a company, based on the company’s level of involvement in a particular industry or the index provider’s own ESG criteria, may differ from that of other funds or of the advisor’s or an investor’s assessment of such a company. As a result, the companies deemed eligible by the index provider may not reflect the beliefs and values of any particular investor and may not exhibit positive or favorable ESG characteristics. The evaluation of companies for ESG screening or integration is dependent on the timely and accurate reporting of ESG data by the companies. Successful application of the screens will depend on the index provider’s proper identification and analysis of ESG data. The advisor may not be successful in assessing and identifying companies that have or will have a positive impact or support a given position. In some circumstances, companies could ultimately have a negative impact, or no impact.