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.