Are ESG Funds Faring Favorably for Retirement Plans?

Plan Participant DataThe stage is being set for incorporating more ESG Funds within qualified plans and other investments.  ESG Funds that focus on environmental, social, and governance (ESG) causes are increasingly being brought to market.  The pressure to incorporate or consider ESG funds into retirement plan investment menus has arrived.  Under the Biden administration, the U.S. Department of Labor (DOL) has stated it will be exploring new rules.  These rules could be more friendly to ESG investments in retirement plans.

Along with the DOL, billionaire activist investor Bill Ackman, CEO of the $13 billion hedge fund Pershing Square Capital, is also getting behind ESG funds.  This according to a recent shareholder letter, excerpts of which were recently published in Yahoo Finance.

According to Mr. Ackman: “We believe that good ESG practices are fundamentally aligned with running a successful business.  As consumers and other corporate customers have become increasingly educated on matters of ESG.  They have begun to avoid companies that contribute to climate change or do not treat their employees well.  This is done while rewarding companies with their business that have sustainable and responsible policies.  Similarly, a growing number of investors have become increasingly concerned about the risks of companies which do not take ESG issues seriously.  These investors avoid investing in companies which do not meet high ESG standard.  This can reduce the valuations and investment returns of these businesses, negatively impacting their cost of capital.”

Mr. Ackman commonly deploys the ESG lens and filters when evaluating investment opportunities and risk.  However, he also said his firm does not have a uniform set of factors it uses to consider potential ESG opportunities.  Its due diligence process varies depending on the company and sector.  As Mr. Ackman conveyed in his shareholder letter:  “Each of our companies’ ESG initiatives generates a materially positive benefit to society.  This fosters customer and stakeholder loyalty, which contribute to the creation of shareholder value.”

An increased ESG funds focus has been lucrative for money managers like Mr. Ackman in recent years.  However, there is still some debate about whether that performance translates inside retirement plans, and, whether or not it is appropriate for ESG funds and related investments to be included in fund lineups.

According a recent article in ETF Trends (linked above), a website focused on ETF education and insights: “Socially responsible investments and ESG-related funds have attracted huge inflows in recent years, but they only make up a minuscule portion of employee-sponsored retirement plans.  Only 2.6% of U.S. corporate plans provide ESG funds as investment options to employee-benefit plans as of 2019.  This suggests that the space is largely an untapped market for fund managers.”

It certainly seems that ESG funds may be an opportunity whose time has come.  However, plan sponsors and retirement plan committees must conduct their own due diligence.  They should always do so before adding ESG funds to their plan’s investment menu.  In particular, it is important to consult with an expert.  This can be the plan’s financial advisor.  They can monitor  performance, track records, management and other due diligence items.  Retirement Committees should ensure any new funds under consideration fit the plan’s investment strategy as detailed in the Investment Policy Statement (IPS).

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