Revision of the ESG in 401 (ok) pension plans

The drive for environmental, social and governance investment has only accelerated over the past year, but some investors are likely to feel like they are falling behind.

Since most individual investors only invest through their retirement plans, many of their ESG investment options are limited. In our most recent research, we took a closer look at investor options to include ESG in their retirement investment decisions. We then dive deep into an often overlooked but potentially powerful way in which investors can have a voice on ESG issues: proxy voting. Morningstar Direct and Office customers can find our full report on ESG investing in 401 (k) plans here.

What does the ESG invest?

Environmental, social and governance investments make sense for many investors as both a risk mitigation and value adjustment strategy, especially for investors with long-term retirement goals.

Environmental factors include the sustainable use of natural resources, energy efficiency and reducing pollution. Social factors prioritize dealing fairly with stakeholders beyond shareholders, including employees and community members from diverse backgrounds. Finally, governance factors focus on transparent and ethical business practices and on balancing competing claims between stakeholders.

As retirement savers plan to grow over several decades, many portfolios with ESG factors could consider reducing risk as the world’s climate changes, the workforce diversifies, and business practices become more scrutinized. Many investors also want positive change and are increasingly aware of the influence of their financial assets in driving such change.

How can investors make ESG investments in their 401 (k)?

In previous research, we’ve found that ESG-minded investors may be baffled in their plans when looking for sustainable funds – funds that have a sustainability-related mandate or that specifically aim to have a measurable social impact.

Although the number of ESG funds available in the industry tripled between 2014 and 2020, we find that still less than 5% of defined contribution plans contain at least one sustainable fund. The US Department of Labor has recently been decidedly skeptical about how trustees should consider ESG factors under the Employer-Sponsored Pension Plan Act. It may not come as a surprise, then, that ESG funds make up only a fraction of a percentage of total assets in 401 (k) plans.

Figure 1 shows three key paths that employees can take into account their ESG preferences when investing in their 401 (k) plans. Since path 1 – investing directly in intentional ESG funds – is not available for many workers, one possible solution is to incorporate other ESG-oriented filters into fund selection. There are two broad and potentially complementary avenues to this approach:

2.1 Consider the fund’s ESG metrics when making investment decisions.

2.2 Think about how a fund votes on ESG-related shareholder resolutions.

Exhibition 1


Looking at ESG metrics at the fund level

Interested investors can rest assured that many non-dedicated ESG funds still look pretty good on inventory-derived sustainability traits such as the Morningstar Fund Sustainability Rating and low-carbon labels. Our research 71% of DC plans have at least one fund with a high Morningstar sustainability rating. Therefore, investors can compare the sustainability ratings of the available fund options and find a plausible way to incorporate ESG factors into their retirement plans.

Looking at ESG proxy voting

Investors can also review how a fund votes on ESG-related shareholder decisions while making investment decisions.

While this is a darker part of the investment process, proxy does seem to attract more interest from investors. As evidence, a majority of investors who responded to an online survey said they would consider a fund’s voting on ESG resolutions as a factor in fund selection. Previous Morningstar Research notes that even dedicated ESG funds do not support sustainability measures at corporate meetings as often as might be expected.

In our research, based on voting results for 2020, we found that many of the funds with the most 401 (k) assets have largely voted against key ESG resolutions. This limits the degree to which plan participants can select funds that match their voting preferences.

All hope is not lost, however, as there are still some funds that support ESG resolutions, such as the Fidelity funds managed by Geode Capital Management.

How investors can start having their say

In the area of ​​investing, there are some efforts aimed at helping investors harness the immense power they share in proxy voting.

For example, the SEC has expressed an interest in increasing the transparency of the proxy voting for mutual funds to give retail investors better insight into the voting of the funds they have invested in on their behalf and ultimately to increase the fund’s accountability to final investors.

There are also several startup initiatives such as Tumelo in the UK that offer platforms and proxy services aimed at bridging the gap between the end investor and the voice that carries their investments through proxy voting and engagement. In our research we find a growing interest in such tools.

Finally, there have been calls recently Investors need to vote with their feet, exercising their influence by redistributing their funds or asking employers to offer different options for retirement. These new proposals in the world of proxy voting can help distribute voting rights among individual investors.

However, for now, individual investors focusing on ESG can first check that the fund companies that own them are voting according to their preferences.

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