Many 401k participants may say they want to invest in environmentally and socially conscious companies, but do they really put their money where their mouth is?
Not so much, according to new research from PGIM’s David Blanchett and Zhikun Liu, a senior research associate at the Employee Benefit Research Institute.
They found less than 10% of DIY investors chose to allocate money to an Environmental, Social, and Governance (ESG) fund when it was offered in their 401k plan. Among those who did put money in an ESG fund, the investment comprised less than 20% of the total portfolio.
The study tracked more than 9,300 self-directed participants in 108 different 401k plans with at least one ESG option and found that only 8.9% chose to invest in the funds. The average ESG allocation of those holding ESG investments was 18.7%, and the average ESG allocation of all participants in plans offering ESG options was a miniscule 1.7%.
“According to our analysis, it’s a minority of a minority of all participants who choose to invest in an ESG fund when it’s available to them,” Blanchett said in a Nov. 1 commentary on the research published in The Wall Street Journal.
Investment strategies focused on Environmental, Social, and Governance (ESG) issues have been receiving increased interest among defined contribution (DC) plan sponsors, consultants, and regulators, and plenty has been written about participants wanting to invest their retirement dollars with companies aligned with their beliefs.
But while there are some clear demographic preferences for ESG funds (e.g., among younger participants with higher incomes), ESG allocations appear to be primarily a function of weak preferences, driven by naïve diversification, the research finds.
There is a notable plan interest effect, whereby ESG allocations are significantly higher in plans where general ESG usage is higher. Participants who self-direct their portfolios have significantly lower expected returns than those using professionally managed investment options, such as target-date funds, which is an important consideration for plan sponsors when adding ESG funds to the core menu to the extent they entice participants to self-direct their accounts.
“Setting aside the efficacy of an ESG strategy, I am concerned that including ESG funds in a defined-contribution plan could result in worse performance for participants to the extent that it encourages investors to build their own portfolios, rather than choosing a target-date fund,” Blanchett writes in the WSJ, adding that investors wanting ESG exposure in their retirement plan would have to forego the default option and build the portfolio themselves. “And the odds of the participant-built portfolio being ‘better’ than the target-date fund is relatively low, since target-date funds are highly diversified and built by investment pros.”
Overall, the research paints a mixed picture about the actual participant interest, and drivers of demand, for ESG funds in DC plans and suggests that plan sponsors should take a thoughtful approach when considering adding ESG funds to an existing core menu.
SEE ALSO:
• 3 in 4 Participants Don’t Know What ‘ESG’ Means. Shlomo Benartzi Wants to Help
• Final ESG Rule Now Under White House Review
• TDF Investors ‘An Oasis of Calm’ Despite Market Volatility
Veteran financial services industry journalist Brian Anderson joined 401(k) Specialist as Managing Editor in January 2019. He has led editorial content for a variety of well-known properties including Insurance Forums, Life Insurance Selling, National Underwriter Life & Health, and Senior Market Advisor. He has always maintained a focus on providing readers with timely, useful information intended to help them build their business.
