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Retirement plan advisers expect Labor Department rules to boost ESG options

Investors said to want environmental, social options

Labor Secretary Marty Walsh's department is expected to make ESG investment options available with new guidance.
Labor Secretary Marty Walsh's department is expected to make ESG investment options available with new guidance. (Tom Williams/CQ Roll Call)

As the Labor Department mulls a proposed rulemaking on environmental, social and governance investment options by retirement plans, advisers say the rules are likely to temper a “chilling effect” caused by the prior administration’s guidance.

Advisers say more retirement savers are asking about ESG investing and that the forthcoming rules could place them on equal footing with many retail and institutional investors who examine factors such as environmental sustainability and corporate responsibility on social issues alongside traditional financial metrics.

“I don’t know if DOL is going to go as far as requiring plan sponsors to think about ESG investments as part of a plan menu, but I am pretty confident we’re going to get a level playing field,” National Association of Plan Advisors Executive Director Brian Graff told attendees as he led a panel discussion of experts during the NAPA 401(k) Summit this week.

Retirement plan fiduciaries haven’t had that much leeway in directing investments into ESG options. Experts are hoping that will change with updated Labor guidance. In December, the department’s Employee Benefits Security Administration issued a final rule that required retirement plan advisers to select investments based on “pecuniary factors.”

That policy limited ESG options for retirement plans, and many stakeholders reported a “chilling effect,” according to the Labor Department, which said in March it wouldn’t enforce that policy and would draft new rules.

President Joe Biden also issued an executive order that directed federal agencies to consider financial risks tied to climate change. The order specifically asked the Labor Department to consider rescinding the previous administration’s rule while taking steps to protect worker pensions and retirement savings.

Senate Democrats introduced legislation to amend a law known as the Employee Retirement Income Security Act to specifically allow fiduciaries to consider ESG factors in selecting investment strategies for employer-sponsored plans.

“Retirement plan sponsors and participants deserve the freedom to choose the 401(k) investment that best suits their needs,” Graff, who is also CEO of the American Retirement Association, said in a prior statement in support of proposed legislation.

ERISA governs a broad range of retirement and health benefit plans. This includes defined benefit plans, such as pensions; defined contribution plans, such as 401(k)s for private sector employees and 403(b)s for public educators and employees of nonprofits and government entities; and many other variations.

These plans contain more than $10 trillion in assets and cover more than 150 million American workers and their dependents, according to Labor Department data. Retirement accounts are also the vehicle through which the vast majority of Americans invest in capital markets.

While more than half of Americans are in the market, less than 15 percent hold stocks directly, according to the Pew Research Center. Most stock market holdings are indirect, through retirement accounts.

Labor regulations may have so far kept many ESG options away from retirement savers despite a rapidly growing interest in those investment strategies.

The total assets under management at funds focused on ESG last year surged to more than $40 trillion, almost twice the size of the U.S. economy, from $22.9 trillion in 2016, according to Opimas LLC, a management consultancy focused on global capital markets.

Demand for more choices

Investors worldwide are seeking more ESG options, according to another panelist, Charles Nelson, vice chairman and chief growth officer of Voya Financial.

“We meet with analysts and investors, and every time there’s a question around ESG,” Nelson said at the event. “I think this is one of the greatest opportunities for advisers in your practices as you go forward, because businesses, whether they’re publicly traded or they’re privately held by private equity or ultimately a hedge fund, they’re getting asked these questions.”

Another panelist noted it gives plan advisers more credibility with clients when they can discuss and offer ESG options.

“You’re now not just the guy or gal that comes in to do the 401(k) review — you become a strategic business partner with them, so it puts you at a much different level,” said Jania Stout, senior vice president at OneDigital Retirement. “I think that’s a huge opportunity for us as advisers.”

Joe DeNoyior, president of retirement and private wealth with HUB International, said he hopes plan advisers don’t merely offer retirement savers a single ESG option.

“[W]e’re starting to hear from our advisers, saying we can’t just put one in,” he said. “If ESG portfolios are the No. 1 portfolio that is attracting assets for the wealth side, then maybe we should market it a little bit differently, like having a one-stop solution for these participants in the ESG side.”

Other panelists included Karen DiStasio, head of retirement consulting services at Commonwealth Financial Network, and Donald MacQuattie, co-head of institutional fiduciary solutions at Raymond James.

MacQuattie said he’s not seeing a huge demand for ESG right now, but he said the Labor Department rules might give advisers more comfort offering these options.

DiStasio noted the quality of data could be improved and said investors can’t simply take third-party data at “face value.”

“You’ve got to do the homework, like we do on any investment,” she said.

Nelson, from Voya Financial, agreed and said that vague terminology remains a challenge for ESG-minded investing in retirement plans.

“I think for many recordkeepers, most of us will use a source or two to determine if a fund is ESG certified or not,” Nelson said. “We have the capabilities, so we can do a lot of those types of things, but the broader challenge that I think we have with it is that it’s not necessarily a litmus test, it’s not either yes or no, because many investment managers and fund managers will apply and utilize ESG principles in their investment philosophy and their processes.”

The panelists pushed back on ESG skeptics who claim that this investment philosophy requires a sacrifice in financial performance.

“I don’t think that just because you choose an ESG fund, that you’re not going to get good performance,” Stout said. “The funds we found are meeting the criteria. … I think there’s enough out there that you can still provide good performance, but also be more relatable to the people that are going to be the major labor force in the next few years.”

While ESG proponents and retirement plan advisers alike continue to await the updated framework from the Labor Department, experts said ESG questions are becoming almost standard practice in public sector funds’ requests for proposals. DeNoiyer said HUB International is seeing an increase in questions about ESG topics, particularly among larger plans.

“It wasn’t just to check a box in their RFP; they actually cared about those issues when it came to our investment due diligence process,” he said.

One notion shared by all the panelists: ESG investing is here to stay.

“Look, you can run your practice how you want, and you all should, but there’s a reason investors and shareholders are asking about this around the world and increasingly in the U.S,” said Nelson. “And I really believe it’s going to continue to build here in the U.S., and those advisers that lean into it and can find a way to engage with their customers in a different way on this will find some new growth as well.”

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