As retirement plans are adding environmental, social and governance (ESG) options to their investments, they seek direction over which strategies will resonate with their participants and still uphold their fiduciary responsibility.
Recent additional guidance from the U.S. Department of Labor may have created some confusion.
ESG Performance Can Clear the Hurdle
A common misperception about sustainable investing strategies (those that use ESG data) is that investors are giving up performance. In fact, strong risk-adjusted performance relative to non-ESG investments is attainable.
Proper due diligence is critical to confirm that the objectives of sustainable investing strategies fit the objectives of retirement plans. The most comprehensive study we have seen analyzed the findings of more than 2,000 previous studies and found that 90 percent of them confirmed that ESG factors had a neutral or positive relationship to financial performance.
In other words, at worst, integrating ESG data into the investment process may not hinder performance in the majority of cases.
Additionally, tilting an index in a passive investment towards companies with stronger ESG profiles tends to limit risk and participate in long-term opportunities, according to MSCI ESG Research.
Other studies back up these findings, indicating that companies with high ESG practices tend to exhibit better risk management. They also are less exposed to controversial headlines that may cause losses.
Keeping the evidence on performance and risk management in mind, a “field assistance bulletin” released last month by the U.S. Department of Labor said, “there could be instances when otherwise collateral ESG issues present material business risk or opportunities to a company . . . in such situations these ordinarily collateral issues are themselves appropriate economic considerations and this should be considered by a prudent fiduciary.”
But it goes on to say that retirement plans (defined benefit or defined contribution) “must not too readily treat ESG issues as being economically relevant to any particular investment choice.”
To some, this may appear that the Department of Labor is walking back from previous statements by saying that ESG is not material to risk and return analysis.
However, we believe that these statements are building on, not replacing, statements (interpretive bulletins) from 2015 and 2016 recognizing ESG as a component of a prudent fiduciary investment process. This is a modern view of ESG integration within a portfolio and is consistent with Northern Trust Asset Management’s sustainable investing philosophy.
We think the most recent statement is meant to clarify and reinforce the prudent fiduciary investment process that must always take place.
In our view, this is aligned with growing global consensus, such as the European Commission’s recommendation to recognize sustainability in fiduciary duty, among others.
In the end, we think appropriate management of ESG strategies can create long-term shareholder value. ESG analytics can capture new opportunities not picked up in traditional analysis, and ESG is certainly a risk factor to consider as we discussed in a recent blog.
Retirement Plans Responding to Growing Demand
This is good news for plan participants as it underscores the importance of putting their needs first, while also allowing plan sponsors to respond to the growing demand and interest that participants demonstrate for access to sustainable investing strategies.
ESG analytics have become increasingly sophisticated over time and we believe the track records of investment strategies that use these analytics support decisions by retirement plans to add sustainable investing strategies to their menus.
This new guidance reinforces the principles and framework governing plan participation in ESG investments, but does offer clarification points for plans to consider. We continue to believe that ESG can play an important role in fulfilling retirement plans’ fiduciary responsibilities to their participants.
Mamadou-Abou Sarr is Director of Product Development and Sustainable Investing, Emily Lawrence is Senior Specialist for Sustainable Investing, and Thomas Wackerlin, CFA, is Equity Strategist with Northern Trust Asset Management.
 Friede, Busch and Bassen ESG and Financial Performance: Mapping the Global Landscape 2015