ESG Faces Headwinds to Adoption in U.S. Defined Contribution Market

ESG Faces Headwinds to Adoption in U.S. Defined Contribution Market
Plan sponsors’ ESG preference takes a back seat to performance and price

March 2019, Boston – Despite an uptick in environmental, social, and governance (ESG)-focused conversations in the defined contribution (DC) market, ESG-oriented investment options face headwinds to widespread adoption. Global research and consulting firm, Cerulli Associates, notes that fee sensitivity, the notion that ESG investing entails a trade-off in performance, and the regulatory environment in the DC market present barriers to adoption.

Cerulli survey data shows that plan participants and plan sponsors are generally supportive of ESG-oriented investments in concept. More than half of participants agree with the statement, “I prefer to invest in companies that are environmentally and socially responsible.” Additionally, 46% of 401(k) plan sponsors describe ESG factors as a “very important” consideration when selecting 401(k) plan investments. However, plan sponsor perspectives on ESG factors differ when contextualized with other investment attributes.

When Cerulli asked plan sponsors to identify the top-three most important attributes when selecting 401(k) plan investments, “environmental and social responsibility” ranked last with 16% of responses. Long-term investment performance and cost of investments were the top-ranked attributes, gathering 45% and 38% of responses, respectively. “Data shows that plan sponsors care about ESG factors, but they place a greater emphasis on performance and price,” explains Dan Cook, a research analyst in the retirement practice at Cerulli.

Guidance issued by the Department of Labor (DOL) in 2018 explicitly scrutinizes the use of ESG-themed investments as a plan’s qualified default investment alternative (QDIA). “The best path for ESG-oriented funds to gather assets in the DC market is in a QDIA role, but this recent guidance and the idiosyncratic nature of ESG investing create significant hurdles,” says Cook.

“This guidance raises an important point related to ESG investing in a DC plan context,” continues Cook, “ESG investments must be prudent options for all plan participants, not a select group or sub-segment.” For example, a small business owner may have strong convictions regarding environmental and social issues and prefer to personally invest in accordance with these views. “This does not mean that participants in the business owner’s 401(k) plan should be automatically enrolled into an ESG-oriented target-date fund without sufficient due diligence conducted on non-ESG alternatives,” states Cook.

In addition to these findings, the first quarter 2019 issue of The Cerulli Edge—U.S. Retirement Edition examines developments in the corporate DC space influencing the use of managed accounts, ESG investing, target-date funds, and cash balance plans.

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