Demand for ESG investing has risen dramatically in recent years, but you’d hardly know it judging by the investment menus of most 401k plans.
While sustainable funds continued to attract record flows from investors in 2020, only 3% of 401k plans offer an ESG option currently—even though most investors only invest through a tax-advantaged retirement account, according to a new study from Morningstar.
As a result, the study finds, some plan participants are seeking alternative routes to understand, and potentially influence, their ESG investment exposure. Theoretically, plan participants could choose among funds based how funds voted on ESG issues on the proxy ballot.
The study—The Power of the Proxy in Retirement Plans—found that 61% of individuals surveyed felt that ESG issues should be addressed in their funds’ proxy voting, 75% indicated that they would like to have more of a say in how their funds voted, and a little over 50% would consider a fund’s proxy voting record in making fund choices. However, funds with the most 401k assets regularly vote against key ESG resolutions and tend to follow the voting strategy set at the asset management level.
A few asset managers dominate the 401k fund space, which limits the degree to which plan participants can choose funds to align with their voting preferences. Morningstar notes that American Funds (offered by Capital Group), Vanguard, and Fidelity command the lion’s share of 401k business across workplaces. For plans dominated by funds offered by asset managers with low support for ESG issues on the ballot, this means less choice for plan participants when it comes to ESG proxy voting.
Given that most investors only invest through tax-advantaged retirement accounts, these accounts can play a vital role in providing ESG investing options.
In the study, Morningstar examines the current options for retirement savers to understand and incorporate ESG considerations into their 401k—such as the Morningstar Sustainability Rating and the Morningstar Portfolio Carbon Risk Score.
Given the dearth of intentional ESG fund options in DC plans, Morningstar’s Sustainability Rating may offer an alternative way for investors to incorporate ESG considerations across their strategies. Some 71% of DC plans offer at least one fund with a high Sustainability Rating and these options accounted for 10% of assets available in plans. Metrics like the Morningstar Sustainability Rating and the Morningstar Portfolio Carbon Risk Score offer fund-level weighted aggregations of the ESG attributes of a fund’s underlying holdings.
The SEC’s interest in strengthening mutual fund proxy voting transparency—announced in March—is aimed at giving retail investors more insight into how their money is voted, especially in light of the growing interest in ESG shareholder proposals. SEC acting chair Allison Lee cited retirement savings’ contribution to index fund investing as a primary consideration in this initiative.
“This year, the Division is enhancing its focus on climate and ESG-related risks by examining proxy voting policies and practices to ensure voting aligns with investors’ best interests and expectations, as well as firms’ business continuity plans in light of intensifying physical risks associated with climate change,” Lee said in March. “Through these and other efforts, we are integrating climate and ESG considerations into the agency’s broader regulatory framework.”
It’s no wonder the SEC is keeping a closer eye on ESG, given its recent growth. Assets under management in sustainability-focused funds neared $2 trillion after record inflows during the first quarter of 2021. During the first three months of the year, global inflows into ESG funds hit $185.3 billion, according to Morningstar.
Overall, assets in ESG funds jumped 17.8% compared to the fourth quarter of 2020.
To download the “The Power of Proxy in Retirement Plans” from Morningstar, click here.
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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.
