On June 24, the Department of Labor’s (DOL) Employee Benefits Security Administration (EBSA) issued a proposed rule for the Financial Factors in Selecting Plan Investments. The rule seeks to clarify guidance for inclusion and selection of Environmental, Social, Governance investments (ESG).
Just as background, ESG investment fund managers build portfolios using techniques and tools that seek to incorporate analysis of the stock or bond issuer’s practices on environmental, social, and governance principles. It also integrates traditional financial analysis to determine a securities investment merits. Historically, ESG investment funds used exclusionary selection techniques (i.e. screening out the poorest scoring ESG stocks and/or bonds). While exclusionary ESG strategies still exist, ESG investment managers have evolved to offer more proactive strategies. These include, but are not limited to, actively managed funds or index-based using indexes that are composed of ESG principles. Additionally, many traditional investment fund managers have incorporated ESG tenants directly into their investment philosophy. Over time, some investment professionals believe distinctions between ESG and non-ESG investments will dissipate.
ESG investments have long been part of defined contribution investment menus. According to the PSCA 2019 403(b) Plan Survey, 34% of all 403(b) plans offer some type of ESG investment to their participants; this increases to 45% for plans with 1,000 or more participants. This trend has continued to gain momentum over the past years as investors seek to align their investment portfolios with their personal beliefs.
The DOL has periodically updated guidance on ESG investments over the past three decades. As part of the press release for the proposed rule, the Secretary of Labor stated, “Private employer-sponsored retirement plans are not vehicles for furthering social goals or policy objectives that are not in the financial interest of the plan. Rather, ERISA plans should be managed with unwavering focus on a single, very important social goal: providing for the retirement security of American workers.”
At this time, we believe the following are important takeaways for plan sponsors of defined contribution plans:
- ESG investments are not appropriate for a plan’s qualified default investment alternative
- Document the inclusion of ESG criteria into your investment policy statement
- ESG options should be included in an investment menu because you reasonably believe that they have a positive economic impact on the expected return and/or expected risk of an investment.
- ESG options should not be included just to appease participants or make a subset of your plan population feel good
- ESG options should be monitored and held to the same standards as other investment options
We will continue to monitor developments from EBSA as this preliminary rule moves forward and public comments are received over the coming months. This is sure to garner attention from the financial services and plan sponsor community.
Additionally, Multnomah Group will hold a webinar later this month if you are interested in learning more about ESG investments.
**Update August 2020**
If you're interested in learning more about ESG investments, watch our webinar recording on the topic.
Multnomah Group is a registered investment adviser, registered with the Securities and Exchange Commission. Any information contained herein or on Multnomah Group’s website is provided for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Multnomah Group does not provide legal or tax advice.