Socially responsible investing guidance is elusive for 401k plan sponsors. “The Department of Labor has problems with socially responsible investing, doesn’t it?” The client who asked me this question had requests from millennials, to put such a fund into the company’s 401(k) plan, and he was seeking advice about how to respond.
Socially responsible investing includes funds that take environmental, social and governance (ESG) factors into account when selecting the fund’s underlying investments. They are often referred to as ESG Funds. Callan’s Sixth Annual Survey shows an increasing usage of funds which incorporate socially responsible investing in other areas. What about 401(k) plans?
Many fiduciaries share my client’s confusion about what the Department of Labor has said on this subject, and whether the Department of Labor’s new guidance changed the rules. That may be why fewer than 10% of 401(k) plans currently offer such funds. I explained to my client that the Department of Labor doesn’t prohibit taking ESG factors into account, although it has set out some rules to follow if you decide to include such a fund in your investment menu.
There are options with track records. Several ESG Funds have been in existence for a period of at least three years with solid performance. More choices are becoming available as vendors respond to strong interest among millennials. Black Rock and Wells Fargo have announced that they are developing target date funds that take ESG factors into account.
Here’s what you need to know:
You can –
- Use socially responsible investing funds even if you haven’t got a specific evaluation process set out in writing (though I recommend adding a section to your investment policy statement).
- Make a socially responsible investing fund an optional or default investment if it performs as well as comparable non-ESG funds and doesn’t assume additional risk. A default fund should also be consistent with participant views.
- Find socially responsible investing funds that take ESG factors into account even though they may not be referred to as ESG funds.
- Make ESG and non-ESG alternatives available in the same asset class.
You should not –
- Offer a socially responsible investing fund that is risky or lags the performance of comparable funds that are not ESG Funds. (However, this may not be a big issue in the real world, as a study by Oxford researchers showed that these funds don’t have a performance handicap and that they may even have a performance advantage.)
- Incur significant plan expenses fighting for shareholder proposals or engaging in proxy fights relating to ESG issues.
- Assume that all ESG or socially responsible investing funds are the same. Some will exclude entire industries, and others will focus on companies with good practices.
While these considerations may seem daunting to company fiduciaries, adding ESG funds to your 401(k) plan can attract millennials to work for you and incentivize them to contribute more to your plan. When Bloomberg added an ESG fund to its 401(k), millennials were the largest identifiable group investing in the fund. According to the same article, Bloomberg even amended its investment policy to provide that efforts would be made to identify at least one fund that considers ESG factors in every fund search, though most plans haven’t gone that far.
For those company fiduciaries and managers who do want to make an ESG or a socially responsible investing fund available, the Department of Labor’s guidance must be followed; however, the guidance does not stand in the way.
Carol Buckmann is a founding partner at Cohen & Buckmann PC, and has practiced at major law firms specializing in the areas of employee benefits and executive compensation for over 30 years. Carol frequently blogs, writes articles and is quoted in the media about current employee benefit issues.