ESG Funds Fiduciary Obligations Balance Duty with Demand

Secure Act ChangesESG funds fiduciary obligations seem to be mounting.  Are the ESG funds fiduciary obligations “good” for retirement plan participants?  And are ESG funds’ investment objectives aligned with the obligations of retirement plan committees and fiduciaries?  Do all ESG funds fiduciary obligations serve the best interests of plan participants?  It is difficult to say at the moment.  However, the trend for ESG funds fiduciary obligations is clear.  In coming years, demand for ESG funds in retirement plans is likely to increase.

The biggest wealth transfer in history is about to happen over the next three decades as Gen X’ers, Millennials, and Gen Z’ers inherit some $70 trillion from their parents and grandparents.  Thus, it’s important for financial professionals and retirement plan fiduciaries to understand how these generations differ from their predecessors.

One of the biggest differences?  Gen X’ers, and particularly Millennials and Gen Z, are more socially conscious investors than previous generations, according to a recent article written by Treasury Partners’ Steve Bogner, in thestreet.com.  They evaluate investments through the lens of ESG.  According to TheStreet, that means:

  • Environmental. Is the company a good steward of the natural world?
  • Social. Does the company treat its community, suppliers, customers, and employees with respect?
  • Governance. Are the company’s leadership, executive pay, shareholder rights, internal controls, and audits all consistent with the highest expectations?

What do the ESG funds fiduciary obligations mean for retirement plan participants?  Even when offered inside of a retirement plan, ESG funds may not always be in line with a participant’s own investment goals.  So fiduciaries have an obligation to educate participants on that fact, and participants should consider several factors before investing, including performance.  In short, it is retirement plan committees’ and fiduciaries’ responsibility to educate participants on the potential impacts of investing in ESG funds.

ESG fund rules are under review as the Biden administration seeks to alter policy put in place under former President Trump.  Retirement plan committees and fiduciaries should pay attention to Department of Labor guidance, however, it is critical to understand that guidance will change as Presidential administrations come and go.  Case in point:  Trump-era rules focused on “pecuniary” factors in ESG funds, meaning “a factor that a fiduciary prudently determines is expected to have a material effect on the risk and/or return of an investment based on appropriate investment horizons consistent with the plan’s investment objectives and the funding policy established pursuant to section 402(b)(1) of ERISA.”  Biden’s DOL is not likely to adhere to the same criteria.

Nonetheless, ESG funds fiduciary obligations related to the risks to plan participants and sponsors should be unwavering, regardless of government policy.  To that end, Steve Bogner, in TheStreet.com article asserts the following:

  • Using an ESG investment as the Qualified Default Investment Alternative (QDIA) in a retirement plan heightens liability risk exposure for retirement plan committees and plan sponsors
  • Leveraging a traditional fund menu with investment options from a variety of asset classes has traditionally been prudent under ERISA
  • Plan fiduciaries who want to offer ESG options in their plan may do so, in select numbers.  Retirement plan advisers should document why these are viable investments, and the ESG funds should be benchmarked regularly for performance and reasonableness of fees.

In addition, retirement plan committees and fiduciaries should, when applicable, educate themselves and rely on input from the plan’s financial professional on why it’s vital to view ESG options as a complement to the existing fund lineup, and possible risks of investing exclusively in ESG funds.  Participants should also receive proper education on the impact of ESG funds.

While there is clear demand for ESG funds from retirement plan participants, committees and plan fiduciaries should seek to balance that demand with prudent investment offerings and practices that will help to support successful retirement outcomes.

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