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Retirement Plans Will Be ‘Next Evolution’ in ESG Investing

Following new guidelines from DOL, retirement plans will lead push in spreading ESG investing themes

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A DOL interpretive bulletin in October paved the way for fiduciaries to safely use ESG investments in ERISA plans. (Illustration: Ellen Weinstein) A DOL interpretive bulletin in October paved the way for fiduciaries to safely use ESG investments in ERISA plans. (Illustration: Ellen Weinstein)

The next push in ESG investing will come from retirement advisors following the Department of Labor's new interpretive bulletin that replaced language warning fiduciaries away from such investments in 2008, according to Gregg Sgambati, head of ESG solutions for S-Network Global Indexes.

The first people impacted by the change will be lawyers, Sgambati said, as “it's somewhat technical” and is still “being digested by investment managers and those who are involved institutionally.”

It’ll take some time to reach retail and individual investors, he said, but when it does, it’ll be through retirement plan sponsors, who are many investors’ first — or only — access to financial advice.

“Once they start rolling out ESG into their platforms, then we’ll see the retail space changing its approach by wanting more information and wanting to understand it better,” and that will force advisors to become more educated in this area, Sgambati said in an interview.

The DOL's New Interpretation

The DOL's 2008 interpretive bulletin stated that considering “economically targeted investments,” or those that provide economic benefits in addition to the financial ones they provide the investor, in ERISA retirement plans “should be rare,” and that when they are used, they should be extensively documented to show they’re in compliance with “ERISA's rigorous fiduciary standards.”

Although economically targeted investments weren't explicitly banned by the 2008 interpretive bulletin, it “gave cooties to impact investing,” as Labor Secretary Thomas Perez said in October.

As investment analysis has improved since then due to better metrics and tools, the 2008 guidance has “unduly discouraged” fiduciaries from using ESG investments in retirement plans, according to the DOL.

“Environmental, social and governance issues may have a direct relationship to the economic value of the plan's investment,” DOL wrote in the 2015 guidance, released in October. “In these instances, such issues are not merely collateral considerations or tie-breakers, but rather are proper components of the fiduciary's primary analysis of the economic merits of competing investment choices.”

Importantly, when considering investments that are “commercially reasonable” for the plan, fiduciaries don't have to view them as “inherently suspect or in need of special scrutiny merely because they take into consideration environmental, social or other such factors.”

Sgambati said the new bulletin “makes it easier for investment advisors in retirement plans and other types of ERISA plans to incorporate ESG or socially responsible investing themes into the investments.”

S-Network provides ESG rating tools for investment managers. “We want to see these types of ratings available on a retail investment platform,” he said. “We’re not there yet. Really the average retail retirement investor is going to look to their financial advisor or their retirement plan to provide them the information about this. That's where the next evolution will be, when retirement plans start to make this part of their platform and start to talk to retail investors about the benefits of investing in these themes.”

Some of those benefits include returns that are at least as good as traditional investments and lower risk over time.

“Incorporating that in an investment [portfolio] is wise,” he said. “Retail advisors can share that story, but then they can also share that it works with values” the investor may be trying to satisfy.

Sgambati noted millennials are driving a lot of the interest in values-based investing, but added they aren't the only investors who want to do more with their money. “There's a lot written about the values of millennials and how they’re bringing their values to the conference room when they talk about how they’re going to invest, but smaller retail investors also have values,” he said. “When they say, ‘I want to make an impact with my money and make my investments be good as well as have a good return,’ it's up to advisors to show that you don't have to give up anything necessarily to have good values.”

If investors do end up giving up immediate returns, Sgambati said, they’re trading them for lower risk over the long term. “There's good research from investment managers and academic researchers that eliminating companies that have low ESG ratings can reduce risk in the portfolio, in addition to some better returns.”

He noted that “better returns” doesn't mean ESG and values-based funds are hitting it out of the park compared to other investment themes. “We’re not talking about big, obnoxious returns, otherwise this whole theme would have hit its glory days years ago,” he said.

Still, some studies have shown that ESG funds perform at least as well as traditional funds. A study by New Amsterdam Partners in 2014 found portfolio values improved when firms with low ESG ratings were removed, and risk was reduced.

A 2015 study from the Social Impact Initiative at Wharton found that on a gross basis, funds that sought market-rate returns kept pace with the S&P 500.

The DOL's new guidance also gives advisors opportunities to have new conversations with their clients, Sgambati said. “Environmental, social and governance metrics and evaluating them in an investment just makes good investment sense,” he said. “Advisors can often identify good investments in that area.”


As far as investors are concerned, ESG investing, impact investing and SRI are essentially the same thing, Sgambati said. There are some nuances, but they’re “slowly but surely melting together.”

“What's picking up now is ‘impact investing,’” Sgambati said. “The definition of impact investing has changed because it had a nuanced meaning even back in 2013 when US SIF [the Social Investment Forum; now the Forum for Sustainable and Responsible Investing] defined it. Now Morgan Stanley has their impact investing practice, and it certainly doesn't mean what US SIF first defined it as.”

Initially, Sgambati said, impact investing referred to strategies that prioritized the non-financial aspects of the investment over returns. “It really was investing to show an impact; where the result of the investment was even more important than the returns.”

ESG examines “numerical areas” of a company to rate it compared to other opportunities, while socially responsible investing tends to employ negative screens. “Again, it's not exclusive,” Sgambati emphasized. “There's a nuance, and I’m not even sure if it's worth discussing with financial advisors anymore. The nuance is for those of us who either know the history or really want to.”

--- Read "Impact Investing Returns as Good as S&P 500: Wharton" on ThinkAdvisor.

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