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A GUIDE FOR PLAN FIDUCIARIES
Environmental, Social and Governance Investing
NEUBERGER BERMAN
A growing number of investors are not only looking for attractive performance from their
investments, but also want their investments to incorporate sustainability criteria. Driven
by enhanced participant interest and significant product developments, plan fiduciaries are
increasingly interested in incorporating environmental, social and governance (ESG) considerations
within defined contribution plans.
To help plan sponsors navigate the world of ESG investing, in this guide, we:
• Define ESG and present the key growth drivers for ESG investments in retirement plans
• Explain key considerations for fiduciaries evaluating ESG investments
• Outline approaches for incorporating ESG investments into retirement plans
ESG INVESTING: A GUIDE FOR PLAN FIDUCIARIES 1
ENVIRONMENTAL
How a company performs as a steward
of the natural environment.
Considerations: Carbon footprint,
pollution and use of toxic chemicals,
waste disposal, preservation of natural
resources.
Potential financial impact: Long-
term stability, lower waste, lower costs,
more efficiency, reduced uncertainty,
ability to adapt to increasingly stringent
environmental regulations or restrictions.
Provide economic solutions to
environmental problems.
SOCIAL
How a company manages its business
relationships with its employees, client
base and surrounding communities.
Considerations: Fair employment
policies, labor relations, supply chain
issues, ethical issues, community
involvement, reliable health and safety
standards, infrastructure and education.
Potential financial impact:
Retain and attract human capital,
increase workplace productivity,
improve security and reliability of supply
chain, potentially avoid interruption,
reputation-damaging controversies and
class-action lawsuits.
GOVERNANCE
How a company is structured, including
business practices and level of
transparency.
Considerations: Management and
board structure, executive compensation
metrics, accounting policies, diversity,
independence, compensation, political
contributions and lobbying.
Potential financial impact: Make
choices that are in the best interest
of shareholders, make good on future
liabilities, implement reasonable
executive pay, prevent corruption.
ESG DEFINEDAlthough it can go by many names and be implemented in a number of ways, ESG investing, in essence, is the practice of incorporating
environmental, social and governance considerations in the investment process.
2 ESG INVESTING: A GUIDE FOR PLAN FIDUCIARIES
We believe that ESG considerations can have a material impact on a company’s financial performance, access to cash flow, growth potential
and risk mitigation. Specifically, responsible and sustainable business practices may help companies plan more effectively and seamlessly adjust
to changing regulations and increasingly scarce resources, avoid potential controversies and deliver on long-term liabilities. A company that can
attract, retain and engage employees—or one that manages resources efficiently and designs products and services to address environmental
challenges—may offer competitive advantages, with the potential to achieve better long-term financial performance than a similar company
that measures poorly on such sustainability issues.
Integrating ESG research into the investment process alongside traditional financial analysis can provide insight into the quality of a company’s
management, culture, risk profile and other characteristics. This practice allows active portfolio managers to identify companies that aim to
effectively plan for the future by capitalizing on the benefits of astute governance, environmental responsibility and broader stakeholder
management.
ESG investing is not an asset class in itself, but an investment approach that can be employed across asset classes and investment
disciplines. ESG considerations have been widely adopted within public domestic equity markets, and have also been successfully
implemented within fixed income, alternatives and private markets. There are also various approaches for integrating ESG considerations in
the investment process, as described below.
ESG INVESTMENT STRATEGIES
NEGATIVE/EXCLUSIONARY: The exclusion of certain sectors or companies involved in activities or industries deemed unacceptable or controversial.
POSITIVE/BEST-IN-CLASS: Investment in sectors, companies or projects selected for positive ESG performance relative to industry peers. This includes avoiding companies that do not meet certain ESG performance thresholds.
ESG INTEGRATION: The systematic and explicit inclusion by investment managers of ESG risks and opportunities into financial analysis.
IMPACT INVESTING: Investment in companies, organizations and funds, often in private markets, with the intention to generate social and environmental impact alongside a financial return.
SUSTAINABILITY THEMED INVESTING:
Thematic portfolio construction around specific ESG areas, such as gender-lens, clean technology, sustainable food and agriculture, renewable energy, or place-based investing.
Source: Forum for Sustainable and Responsible Investment (US SIF Foundation) Report on Sustainable, Responsible and Impact Investing Trends 2018.
ESG INVESTING: A GUIDE FOR PLAN FIDUCIARIES 3
POTENTIAL BENEFITS
We believe ESG investing within retirement plans could have a number of
potential benefits for both plan sponsors and plan participants:
• May provide attractive long-term risk-adjusted returns for plan
participants. The key goal for retirement plan fiduciaries is to be responsible
stewards of capital and to help participants accrue assets for their retirement.
• Enhance corporate reputation and attract talent with retirement
benefits inclusive of ESG offerings demonstrating commitment to all aspects
of sustainability. For example, employees who value their organization’s
diversity profile can now access investments with similar attributes.
• Increase participant engagement in the plan, as participants may
be more likely to contribute to investments that meet both financial and
sustainability needs.
• Align an organization’s mission with plan investments. Many
corporations have built both a brand and reputation on thoughtful ESG
considerations. Having plan investment options consistent with this is an
extension of their efforts. For example, a corporation with a sustainability
focus or mission may want its retirement plan options to align with its
sustainability goals and as a result broaden its impact.
EXPONENTIAL GROWTH WITHIN ESG INVESTING
Investments in strategies that incorporate ESG considerations have experienced significant growth in recent years. This growth is indicative of broad investor interest, including public retirement plans, private retirement plans, religious organizations, education institutions, health care institutions, and small and medium-sized business owners. In fact, 40% of investors surveyed today already own or are interested in ESG investments.1
ESG INVESTING CONTINUES TO GAIN TRACTION
AUM
(Tril
lions
)
3.1 3.8
6.98.7
02468
1012
‘18‘16‘14‘12‘10
12
Source: Forum for Sustainable and Responsible Investment (US SIF Foundation) Report on Sustainable, Responsible and Impact Investing Trends 2018.
U.S. AUM invested in sustainable strategies:
2012 $1 out of every $9
2018 $1 out of every $4
4 ESG INVESTING: A GUIDE FOR PLAN FIDUCIARIES
KEY CONSIDERATIONS FOR FIDUCIARIES
$35,724$29,846$28,342
Dow Jones Sustainability Index – U.S. S&P 500
U.S. Active Large Cap – ESG
$0
$10,000
$20,000
$30,000
$40,000
$50,000
‘18‘16‘14‘12‘10‘08‘06‘04‘02‘00
PERFORMANCE
As fiduciaries, a key focus around ESG investments has been the question of competitive
long-term performance. Evidence is growing that investment strategies that integrate ESG
considerations into the fundamental investment process can positively impact a company’s
profitability. In other words, investing in ESG strategies can provide competitive long-term
risk-adjusted returns. As with other strategies, it is important that fiduciaries consider the
length of track record and the critical mass of assets when evaluating ESG investments.
December 31, 2018
U.S. Active Large
Cap - ESG1S&P 500
Index
Dow Jones Sustainability
Index - U.S.
10-year Return 12.77 13.12 12.40
15-year Return 7.94 7.77 6.75
20-year Return 6.57 5.62 5.35
Source: Morgan Stanley Institute for Sustainable Investing, “Sustainable Signals”, August 7, 2017.
MILLENNIALS
Millennials, born 1982 – 2000, make up more than one-quarter of the U.S. population. With 83.1 million members, this generation outnumbers baby boomers (at 75.4 million).2 A majority of millennials believe businesses can do more to address society’s challenges in the areas of climate change and resource scarcity, and in fact stated that the primary purpose of businesses is to improve society.3
MORE RECENTLY, INTEREST IN ESG INVESTING HAS APPEARED STRONGER WITHIN TWO DEMOGRAPHICS: MILLENNIALS AND WOMEN
WOMEN
Women also have a strong interest in ESG strategies. With 80% – 90% of all women estimated to be solely responsible for their own finances at some point in their lives,4 investments in ESG strategies within this population could continue to grow.
of Millennials want sustainable investing options as part of their 401(k) plans.
90%
Offering ESG strategies in a plan menu can increase engagement with these groups, especially if the plan sponsor is seeking to attract and retain this talent pool.
ESG STRATEGIES CAN DELIVER ATTRACTIVE LONG-TERM PERFORMANCE Growth of $10K – Since Inception of the Dow Jones Sustainability Index (January 1, 1999)
Source: Morningstar. As of December 31, 2018. Indexes are unmanaged and are not available for direct investment. Investing entails risks, including possible loss of principle. Past performance is no guarantee of future results.1. US Active Large Cap - ESG is an equally weighted net-of-fee portfolio that includes all funds that meet the following criteria: Morningstar category of Large Blend, Large Growth or Large Value and deemed socially conscious by Morningstar. The number of funds that had aggregate Fund assets of at least $500 million as of December 31, 2018 included in US Active Large Cap - ESG with a 10-year track record was 33 out of 56; 15-year track record was 26 out of 41 and 20-year track record was 20 out of 27. The hypothetical analysis assumes an initial investment of $10,000 made on January 1, 1999 in the oldest share class of each respective Fund equally. This analysis assumes the reinvestment of all income dividends and other distributions, if any. The analysis does not reflect the effect of taxes that would be paid on Funds distributions. The analysis is based on hypothetical past performance and does not indicate future results. Given the potential fluctuation of each of the Funds’ Net Asset Value (NAV), the hypothetical market value may be less than the hypothetical initial investment at any point during the time period considered. See Additional Disclosures at the end of this piece, which are an important part of this presentation.
of women consider ESG factors when making investment decisions164%
ESG INVESTING: A GUIDE FOR PLAN FIDUCIARIES 5
The first formal position the DOL took on ESG investments, referred to by the DOL as economically targeted
investments (ETIs), was in Interpretive Bulletin (IB) 94-1. In that bulletin, the DOL established the “all things being
equal” test: As long as plan interests were not subordinated and the ETI could be expected to return a comparable
rate of return as investments with similar risks, a plan fiduciary could offer an ETI as an investment option. In effect,
plan fiduciaries could use ESG considerations to break a tie with an equivalent non-ESG option.
In 2008, the DOL added special scrutiny to ESG investing within retirement plans, effectively discouraging plan
fiduciaries from adopting these types of investments. In this guidance, the DOL ruled that investments in ETIs should
be rare, and that when they are considered, their use be documented to demonstrate compliance with ERISA.
In recent years, the DOL has concluded that its 2008 guidance unduly discouraged plan fiduciaries from investing
in ETIs or implementing ESG considerations, even when the investments were economically equivalent. In a 2015
bulletin, the DOL confirmed that, in some cases, ESG considerations have had a direct relationship to the economic
and financial value of the plan’s investment and that ESG issues are proper components of a fiduciary’s analysis
of an investment’s economic merits.5 The DOL reinstated the “all things being equal” test for incorporating ESG
considerations into an investment analysis.
Field Assistance Bulletin 2018-1 reiterates that ESG factors can be material to financial performance and may be more than
just a tie-breaker in investment decision making, but cautions fiduciaries that they should not automatically conclude that
ESG “promote[s] general industry trends or market growth” and that fiduciaries should “not too readily treat ESG factors as
economically relevant.” Therefore a key aspect for fiduciaries is determining that ESG factors are economically relevant, as
well as the importance of selecting managers that can identify ESG factors that may affect financial performance. When it
comes to the core plan menu, the DOL indicated that while replacing a Qualified Default Investment Alternative (QDIA) with
an ESG investment may conflict with a fiduciary’s ERISA duties, the addition of an ESG-themed option may not. Therefore,
plan fiduciaries may consider prudently selected ESG options as an addition to the other non-ESG portfolios on the menu.
EVOLUTION OF DOL GUIDANCE ON ESG INVESTING
ALIGNMENT WITH MISSION OR PARTICIPANT INTEREST
Because sustainability can mean different things to different investors, plan fiduciaries will likely evaluate an ESG strategy or policy in the
context of what’s most relevant to their plan, such as the company’s mission or the average participant’s interest. But the ultimate goal of
retirement plans is to ensure participants have sufficient funds upon retirement. Hence, selecting an approach that not only aligns with mission
or interest but also delivers long-term risk-adjusted returns is a crucial consideration for retirement plan fiduciaries.
COMPLIANCE WITH ERISA GUIDELINES
Some plan fiduciaries have been reluctant to incorporate ESG strategies into their retirement plan investment objectives because of concerns that
focusing on variables other than investment performance and cost may conflict with their ERISA fiduciary obligations. The Department of Labor
(DOL) has recently released guidance on how fiduciaries should, and should not, incorporate ESG considerations in their retirement plans in order
to remain ERISA compliant.
1994
‘All Things Being
Equal’ Test
2008
Special Scrutiny
Added
2015
More Supportive
Guidance from
the DOL
“ A fiduciary’s evaluation of the economics of an investment should be focused on financial factors that have a material effect on the return and risk of an investment based on appropriate investment horizons consistent with the plan’s articulated funding and investment objectives.”6
2018
Reiterating
the Need for
Fiduciary Focus
6 ESG INVESTING: A GUIDE FOR PLAN FIDUCIARIES
APPROACHES TO INCORPORATING ESG IN RETIREMENT PLANS
VEHICLE
Plan fiduciaries considering incorporating ESG into their plan have many choices available to them. Depending on the size of the plan,
fiduciaries may choose to incorporate ESG via a mutual fund, collective trust or separately managed account. With many investment options
now available, plan fiduciaries can select an approach that is in the best interest of their plan participants and beneficiaries:
How are ESG considerations integrated in the investment process?
What sources of data are utilized to identify and assess the ESG considerations in an investment?
How have ESG considerations impacted investment decisions?
What is your approach to active ownership, including engagement and/or proxy voting process and guidelines?
What ESG-related reporting is provided?
• Mutual Funds: The easiest way for plans to select specific
investment options that consider ESG criteria may be through a
mutual fund. At the outset of 2018, 636 mutual funds with $2.58
trillion in assets under management were subject to some form of
ESG criteria.7
• Collective Investment Trusts (CITs): CITs have become a
popular alternative to mutual funds within qualified retirement
plans, as modern CITs offer increased transparency, ease of use
and flexibility. CIT asset growth has outpaced the overall retirement
market with a 7-year CAGR of 14.4% compared to less than 9%
for the retirement market.8 Since 2012, CIT use has grown by 35%
within DC plans, while the usage of mutual funds has decreased.9
• Separately Managed Accounts: Large institutional plans may
have the scale to customize ESG investments in their offering rather
than implementing an “off-the-shelf” approach.
Regardless of the way plan fiduciaries choose to construct their
plan lineup, manager selection is crucial when considering ESG
strategies. It is important for fiduciaries to evaluate the credibility of
the investment process and the investment discipline in incorporating
ESG considerations in the investment process.
FIVE QUESTIONS TO ASK
INVESTMENT MANAGERS TO
EVALUATE ESG PROCESSES
ESG INVESTING: A GUIDE FOR PLAN FIDUCIARIES 7
PLAN DESIGN
Plan fiduciaries often inquire about how to incorporate ESG strategies into a retirement plan. While there are a variety of ways, we believe plan
fiduciaries may want to consider including dedicated ESG strategies on the plan menu as a standalone option, alongside non-ESG options.
Plan sponsors and fiduciaries who choose to add a select number of dedicated ESG strategies to their core plan menu have a great deal of
flexibility today within the marketplace across asset classes.
FUND MENU
EQUITY OPTIONS ESG NON-ESG
FIXED INCOME OPTIONS ESG NON-ESG
ADDITIONAL CONSIDERATIONS
MATERIALITY MATTERS
ESG factors that have significant or “material” impact on financial performance within one industry could have little or no impact in another
industry. For example, according to the Sustainability Accounting Standards Board (SASB), most environmental factors will not have a material
impact on the majority of financial companies but could greatly impact companies within the health care or non-renewable resources industries.
Material sustainable issues include those that:
• Pose direct financial risks
• Are or may be regulated in the near future
• Are becoming industry norms and drive competitive best practices
• Are raised by investors and other stakeholders and threaten brands or license to operate
• Represent opportunities for innovation and growth
Research has shown performance implications regarding material versus immaterial ESG factors. In fact, companies with top quartile
performance on material ESG factors are associated with almost 5% outperformance, whereas companies with a focus on immaterial ESG
factors has led to 2% underperformance.10
WE BELIEVE THAT ACTIVE MANAGERS MAY BE BEST POSITIONED TO IDENTIFY MATERIAL ESG FACTORS
In our view, certain passive strategies may have overly broad ESG screens, lack judgment about materiality, and fall short in maximizing returns
for participants. Active ESG strategies, on the other hand, aim to leverage multiple sources of research and data to conduct the sort of bottom-
up ESG analysis that identifies material and relevant ESG considerations, making them potentially better positioned to achieve ESG objectives
while seeking to increase financial returns.
8 ESG INVESTING: A GUIDE FOR PLAN FIDUCIARIES
NEXT STEPS Selecting and monitoring plan investment options and following a defined process are some of the most important plan governance duties for
retirement plan sponsors. Hence, the logical place to start is the Investment Policy Statement (IPS).
INCORPORATING ESG INTO AN IPS
An IPS often documents a plan’s investment objectives and the due diligence process for selecting and monitoring plan investments.
Consistently following the procedures set forth in the IPS and documenting those decisions has become a best practice for plan governance,
although it’s important to remember that ERISA fiduciary obligations are paramount and an IPS should be reviewed regularly to make sure it
does not conflict with ERISA obligations. If ESG considerations have never before been implemented in a plan, the IPS may need to be adjusted
to reflect how the ESG considerations will be incorporated into the investment selection process. Some aspects that should be discussed by the
investment fiduciaries and potentially addressed in the IPS include:
• Specific ESG considerations or policy. Will specific ESG
considerations or policies be adopted and what will they be? A
wide variety of ESG policies and considerations is available and
it’s important to understand the nuances of the implementation
approaches to determine fit.
• Alignment with existing investment options. Where does ESG
fit in the plan menu?
– Will there be an ESG alternative for certain or all asset classes
featured on the core plan menu?
• Roles and responsibilities. Who will determine the manner
in which ESG considerations or policy will be incorporated and
evaluated? How will investments be evaluated against the ESG
considerations or policy? What benchmarks or ratings will be used?
– Investment committee
– Plan’s financial advisor or consultant
– Third party
• Monitoring process and timeline. How frequently will ESG
considerations or policy be reviewed? Is this different from the
review of the plan’s other investment options?
• Documentation. What additional documentation will be
maintained regarding ESG, if any?
As with any aspect of the investment policy, when outlining the due
diligence process relating to the ESG considerations, it is important
to retain sufficient flexibility to adapt to changes in the industry or
plan needs.
CLOSING THOUGHTS As ESG considerations and policies are becoming more mainstream, plan fiduciaries have access to a variety
of investment options to meet the increasing demand from their plan participants and their beneficiaries.
As plan sponsors begin to encounter a new generation of savers, ESG-integrated investments provide a way
to connect participants’ sustainability preferences with the plan’s investment options while still focusing on
providing strong investment returns. As with all other plan investment options, plan fiduciaries need to be
thoughtful in understanding the various ESG investment strategies available, the credibility of their investment
processes and track records, and their tenure when evaluating them for their plan line-ups.
1 U.S. Trust, “Insights on Wealth and Work,” 2018.2 U.S. Census Bureau, “Millennials Outnumber Baby Boomers and Are Far More Diverse, Census Bureau Reports,” June 25, 2015.3 Deloitte, The Deloitte Millennial Survey, January 2014. 4 Patricia Q. Brennan and Barbara M. O’Neill. Money Talk: A Financial Guide for Women, 2014.5 Department of Labor, Interpretive Bulletin 2015-01, October 26, 2015; Fact Sheet: “Economically Targeted Investments (ETIs) and Investment Strategies
that Consider Environmental, Social and Governance (ESG) Factors,” October 22, 2015.6 Department of Labor, Field Assistance Bulletin 2018-01, April 23, 2018.7 US SIF Foundation Trends Report 2016.8 Erach Desai and Jason Dauwen. DST Systems and ALPS. Collective Investment Trusts—A Perfect Storm, March 2017.9 Callan 2017 and 2018 DC Trends Surveys.10 Khan, Mozaffar and Serafeim, George and Yoon, Aaron S., Corporate Sustainability: First Evidence on Materiality (November 9, 2016). The Accounting
Review, Vol. 91, No. 6, pp. 1697-1724 (Last revised 1 Feb 2017). Performance is from April 1993 to March 2013.
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