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Commentary

The Future of ESG in Retirement Investing

Do investors have sustainable fund options in defined-contribution plans?

Amid the craziness of our current environment, one thing is certain, there is interest in environmental, social, and governance investing. As evidence, fund flows into sustainable funds have continued at a record pace in the first and second quarters of 2020.

Despite market volatility, ESG metrics still capture investors' attention when making hypothetical investing decisions. In fact, we find that providing ESG information can even help people to not over-rely on past returns when making investing decisions.

Despite investor interest in ESG, not much has been said regarding the accessibility of ESG options in defined-contribution plans. We aimed to fill this gap.

Given that there are many ways to incorporate ESG into investing decisions, we examined the accessibility of sustainable investments through three different approaches to ESG:

  • Sustainable Funds: Funds for which ESG incorporation and impact are an intentional focus of their investment process.
  • ESG Consideration Funds: Traditional funds that now declare that they consider ESG when making investment decisions in their offering document or regulatory filings.
  • Morningstar Sustainability Rating: A measure of a fund's ESG-related risk. The sustainability rating is depicted by globe icons: A low ESG risk score equals 5 globes, and a high ESG risk score equals 1 globe.

To run this analysis, we combined 2016 defined-contribution-plan lineup data with 2019 sustainability metric data, resulting in 2016 lineups with up-to-date sustainability information for each of those options.

This allowed us to conduct an "as if" analysis: If plan lineups had remained the same, what would their sustainability characteristics be now? Since ESG in the United States has become far more popular since 2016, we expect that this analysis is a conservative estimate of ESG options in retirement plans.

Investors May Be Disappointed With Defined-Contribution Plan Lineups
In our research, we found that sustainable funds are hard to find in defined-contribution plan lineups. Only about 4.5% of plans had at least one sustainable fund, and they made up, on average, 0.17% of a plan's offerings.

For investors who would like to invest according to their values, the lack of sustainable funds in plan lineups may force them to look at brokerage options instead.

Regarding ESG consideration funds, or funds that mention ESG in their filings, coverage in defined-contribution plan lineups improves, but not by much. Only about 22% of defined-contribution plans had at least one ESG consideration fund, and, on average, these funds only made up 1.05% of a plan's offerings (by number of offerings, not by assets).

Looking to ESG Risk Measures May Offer Alternatives
Given the lack of available sustainable funds or ESG consideration funds, what can interested defined-contribution plan participants do?

One thing they can do is evaluate funds in their lineup for ESG risk. To determine the availability of defined-contribution plan options in terms of ESG risk, we looked at each plan's overall coverage of funds with a Morningstar Sustainability Rating and coverage regarding 4- and 5-globe-rated funds.

We found that 48% of plan options had a sustainability rating. This means that investors can consider ESG-risk exposure when analyzing their retirement options. Not only do investors have options, but most have high-quality options. We found that about 71% of plans offered at least one highly rated 4- or 5-globe fund.

Incorporating ESG Measures in Retirement Decisions
In our research, we found that the accessibility of ESG options in retirement plans varies by the approach. For those looking to invest according to their values, the lack of sustainable funds in defined-contribution plans may force them to resort to brokerage options.

However, not all hope is lost. Investors may still have the option to consider ESG risk when making retirement decisions. We found that most plan lineups offer at least one option with a high sustainability rating.

Overall, the accessibility of funds with a sustainability rating in defined-contribution plan lineups may give investors the opportunity to identify the ESG-risk exposure of their retirement options.