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Is Your Retirement Plan Invested According to Your Values? A Look at ESG Investing and Better Retirement Plan Options

Is Your Retirement Plan Invested According to Your Values? A Look at ESG Investing and Better Retirement Plan Options

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Traditional investing is all about financial returns: We can make our money “work for us” by using it to buy portions of publicly traded companies, risking our dollars on the chance those companies will become more profitable and thereby increase the value of our purchased shares. It’s gambling, at its core, but gambling within a system so enormous and regulated that the financial rewards generally outweigh the risks. Trust in the payoff is what makes retirement plans — 401(k)s, for example — so highly recommended: Over time, we can count on our investments growing.

But the investing landscape has always been a mixed bag. Investors are in the game because they want their money to grow, and companies that rely on investors are incentivized to make their shareholders happy. This forms the basis of what’s called “fiduciary duty,” in which a company’s leadership is legally required to drive financial gain and profits. Unless a company is incorporated as a benefit corporation, with an express social purpose, financial returns are the only metric a public company is required to meet.

Part of this makes sense: We all want our retirement investments to grow. But when companies make decisions that benefit their current bottom lines while putting the long-term stability of our planet and society — and thus, our long-term investments — at risk, a change is needed. That’s where ESG, impact investing, and long-term, holistic risk analysis come in: to ensure fiduciary decisions made today don’t negatively impact the ability for us, our children, or others to make a healthy, stable return in the years to come.

ESG investing (“ESG” stands for environmental, social, and governance) offers new layers of information to financial managers as well as investors — information about how companies are prioritizing the environment, communities, workers, and ethical business practices. The ESG landscape is still fairly young, and legal restrictions have made the space difficult to track and understand. But for investors interested in better aligning their retirement plans with their values, ESG offers a promising pathway forward.

We spoke with two experts about the current ESG investing landscape, what it currently has to offer investors, and how employers and employees can make ESG investing part of their retirement plans.

Jim Roach is a Senior Vice President of Retirement Strategies for Natixis Investment Managers. In this role, he represents Natixis Sustainable Future FundsSM, the first open-ended mutual fund target date offerings that are broadly ESG in the marketplace. Roach has over 15 years of investment industry experience.

Jeff Gitterman is a Co-Founding Partner of Gitterman Wealth Management and a thought leader in the field of ESG Investing. He is the creator of his firm’s SMART (Sustainability Metrics Applied to Risk Tolerance)® Investing Services, which offer investment opportunities for individual clients, as well as research and investing services for other financial professionals in the Sustainable, ESG, and Impact arenas.

Let’s start with the basics. What is ESG investing?

Jeff Gitterman:

I have a metaphor that I use: So 25 years ago, if you wanted to take a road trip, you’d pull this thing out of the glove compartment called a map. You’d unfold it and have a lot of stale data about the trip that you were about to take. It didn’t tell you anything about road closures or traffic or detours or anything else. Today, you get in the car, you have a GPS, you plug in an address, and it gives you lots of additional data that the old map could not provide.

All of that additional data is ESG in the financial world. It’s non-financial data that wasn’t included in your traditional financial reports, but that has become more and more material to stock prices over the last 25 years. 

We’re outperforming our peers, and we’re outperforming our indexes, and that’s because the ESG framework provides us more data and more information to work with.

Jim Roach

In 1975, 83% of the S&P 500’s market value was based on tangible assets that appear in financial disclosures. By 2015, almost 85% of the S&P 500’s market value was based on intangible assets. It’s now 90%. Think about Tesla, Google, and all these companies that have huge valuations with much of it driven by intangibles. Today, it’s all about customer loyalty, brand identity, sustainability, and all of these new issues. 

To be clear, when you get a new GPS, after you put in your address, you then get route preferences. You can take the scenic route or choose no toll roads. That’s your personal preference. That’s like responsible investing or values-based investing or socially responsible investing, which isn’t the same as ESG. ESG is all the data that underlies the materiality of a company that’s not financial. Your route preferences are your own personal values that you want to prioritize on your financial journey. 

There’s a lot of confusion in the marketplace about values investing. That is not ESG. ESG topics are about materiality, they are not exclusionary by definition. So, adding an ESG fund into your 401(k) doesn’t mean that you don’t own fossil fuels all of a sudden. What it does mean is that you probably own the best fossil fuel company in regard to how they treat the environment and their employees and how their board governance is and how many lawsuits they’ve had against them.

Why is it beneficial to consider ESG funds as part of a retirement plan?

Jim Roach:

We believe that ESG investing is a better way to invest in the 21st century. There are lots of stats and studies saying that when U.S. asset managers take ESG risks and opportunities into play, we’re beating the market. We’re outperforming our peers, and we’re outperforming our indexes, and that’s because the ESG framework provides us more data and more information to work with. 

When we ask companies about their policies around social and environmental issues, how they’re retaining employees, what their benefits are like, how diverse their boards are, we’re finding that the companies focused on these elements are outperforming their peers’ stock prices. We’re finding higher returns and less downside risk. But this framework is also benefiting the environment and society. It’s perfectly acceptable when creating a retirement plan to ask questions about ESG because they relate to performance. When companies do the right things, returns reflect that, and that’s not a bad thing to talk about.

We did a study showing that 60% of participants will invest more in a retirement plan, or for the first time, if they know the money is doing social good. Again, we have to clarify that a little bit, because we have to pick investments that are for the participant’s financial benefit. But the collateral benefit is investing in companies that are doing good. 

It’s extremely important that younger workers — millennials, Gen Z-ers — start investing early, but that’s tough, because there are a lot of demands on their money: school debt, housing prices, family. But you can’t replace the time forfeited if you don’t start investing early. It’s important to get them excited about investing, and to show them it can be something they believe in. That’s what we’re seeing with ESG investing. A company we worked with added an ESG target date fund to their plan and saw a 57% increase in enrollment and a 230% increase in monthly contributions. 

Tell us about some of the changes that have taken place recently at the federal level, and how they impact the ESG investing space.

Jim Roach:

The regulatory confusion is a big issue in relation to why the space is where it is. McKinsey and Company, a very large consulting firm, said that by the year 2022, the defined contribution market would be $11 trillion. That makes it one of the largest, fastest-growing spaces in the world. But less than 1% is invested in ESG funds partly because of regulatory confusion. 

Back in 2015, the Obama administration put out an Interpretive Bulletin that contained what was called a “tiebreaker rule.” That rule said that with all things being equal, ESG should be the tiebreaker. That really opened the door for us. But then in 2018, the Trump administration filed a Field Assistance Bulletin, which poured cold water on the tiebreaker rule. 

It’s important to get [young people] excited about investing, and to show them it can be something they believe in. That’s what we’re seeing with ESG investing. A company we worked with added an ESG target date fund to their plan and saw a 57% increase in enrollment and a 230% increase in monthly contributions.

Jim Roach

Now the Biden administration has reversed course on enforcement of the Trump administration rules. Biden wants to come up with a new rule, and I think it’s going to be very favorable to ESG and defined contribution plans, because it’s a framework and is what U.S. asset managers are looking for. So it’s been a bit of a ping pong game. 

But right now, fiduciaries always have to prioritize the economic interest of a participant above all else.

Jeff Gitterman:

We’ve done a complete 180 from a year ago, but it’s still not law. And fiduciaries are still nervous. Employees might be pushing in this direction, but many fiduciaries still aren’t educated. There’s just not enough education about how to get ESG options with your plan yet.

How can I, as an investor or somebody planning for retirement, understand whether a fund is in line with my values?

Jeff Gitterman:

It takes work right now. The SEC is coming down very hard on naming functions. In other words, if you call your fund a “low fossil fuel fund” or a “carbon neutral fund,” can you actually prove that your fund does that? I think we’ll see a big shaking of the tree over the next two years. A lot of companies that rushed to change the name of their funds are now rethinking that and are getting nervous about whether they can back up the rebranding. 

If you want to do your homework, you can read the prospectus of a fund and actually see if it’s ESG. You can also use tools like As You Sow, which will rank your funds for you. Morningstar now offers a globe rating where a five globe is a very high rating for sustainability and ESG.

You have to be careful because a lot of these funds are just screening out the worst actors and giving people a false sense that their money is now actually pushing for the issues that they care about. That’s why a lot of impact is in private markets, because you can get a measure from the impact investment that says whether you are actually improving something you care about.

I don’t want to say that you can’t make an impact in public markets. Activist investor Engine No. 1 got three board seats at Exxon that were not Exxon selections. So public markets can have an impact too, but you can’t directly tie your dollar in a mutual fund to a specific outcome.

You are pressuring the markets in a soft way, but it’s not direct pressure. In your retirement plans all you can do is ESG investing, and ESG funds are more do-no-harm than impact. It’s still a good start, because when it happens on a mass scale, it forces the companies that are doing harm to risk getting left out of these funds and indexes, which in turn forces them rethink how they’re doing business. So, it does have an effect over time, but it’s just not as immediate as private impact investment.

If I’m a business owner looking to provide ESG fund options for my employees’ retirement plans, how should I get started?

Jim Roach:

We think it’s extremely important for growing businesses to have strong benefits because you want to retain and attract the best talent. People tend to get a little nervous; “benefits are expensive, what if I can’t afford it?” But there are a lot of ways that you can do this that are not as cumbersome or as expensive as they used to be, whether you’re a five- or 250-person company.

I would say you should start by getting advice from a financial advisor. While you’re interviewing a financial advisor, whether you already have one or you’re looking to bring one on, ask them about their beliefs about ESG investing. Best case, ask them what their thoughts are before you hire them. The company and the people at the company pay these people to make these decisions, so you should feel comfortable pushing the work onto them. 

In your retirement plans all you can do is ESG investing, and ESG funds are more do-no-harm than impact. It’s still a good start, because when it happens on a mass scale, it forces the companies that are doing harm to risk getting left out of these funds and indexes, which in turn forces them rethink how they’re doing business.

Jeff Gitterman

If I’m an employee, and I want ESG funds to be part of my retirement plan options, what options do I have?

Jim Roach:

You can have a conversation with your HR person. Ask them about your 401(k) plan and what investments are included. You can ask the HR person to have a conversation about ESG options with the advisor or consultant involved in the plan. 

Still, it’s helpful for the participant to understand the fiduciary duty that a plan sponsor has. Plan sponsors have to put the economic interests of the participant above all else. In today’s regulatory world, we believe you cannot request to have 100% fossil-fuel-free investments, because that is putting value ahead of economic performance. But you can have a conversation about ESG investments. 

What if my employer doesn’t plan to move in this direction? Is there anything I can do to ensure my invested money is still supporting my values?

Jeff Gitterman:

It’s very difficult. Some retirement options have a broker exit, so you can actually exit the retirement plan and go to a brokerage account. If you do have the option, that’s a way for the employee to exercise control. A lot of employers defer to that option rather than have the fiduciary responsibility of their plan options currently being out-of-line with the government. 

Those outside brokerage accounts are great and you can go to places like Morningstar and As You Sow to screen for funds that align with the things you’re concerned about. You can then purchase those funds through the brokerage account. 

The psyche of the marketplace is shifting. The younger generations are inheriting trillions of dollars from the baby boomers over the next 10 or 15 years, and they’re going to have the capital to make the decisions. Women care more, children care more, and they will control more and more of the capital. So, it’s now hard to imagine a world where sustainably focused companies in the industry don’t outperform companies that don’t care.

Jeff Gitterman

If you don’t have a brokerage option available, you can still go to Morningstar and As You Sow and screen your funds. Just because a fund doesn’t have ESG in the name it doesn’t mean that it doesn’t score very high on Morningstar’s globe ratings. A lot of globe ratings are not ESG-named funds, but they still screen well.

Is ESG investing growing? What are the trends like?

Jeff Gitterman:

In the last six months, we’ve seen a huge tipping point. There were a number of issues last year, COVID and George Floyd, that pushed us toward a tipping point for the ESG industry. I don’t think it was the administration change. I think it was those two issues, on top of climate change already bubbling up as a main stage issue. 

I said back in 2015 that I thought ESG would first become sustainable in 2015. And I think that was true. There was a very steady ramp-up in 2015. In the last six to 12 months that ramp-up has gone vertical. That’s really exciting. It’s also unfortunately indicative of the fact that we’re late. As much as I like to be right about things, the data on climate change, for example, is getting scarier and scarier. It’s the first time in my life that I’m right and not happy about it.

This is a long-term game. There should be no negative impact of using ESG data to look at the companies that you invest in. Long term, I believe there should be some potential benefit, because resources are becoming scarcer, investors are caring more, and those investors are also consumers who are caring more. So, these issues, as they become more public, are going to hurt companies that don’t care themselves. 

I saw Kevin O’Leary from Shark Tank the other day on Clubhouse. He was saying that, if you’re not moving toward sustainability, you’re going to be in trouble. You’re not going to be able to access capital. It’s a very matter-of-fact statement. The psyche of the marketplace is shifting.

The younger generations are inheriting trillions of dollars from the baby boomers over the next 10 or 15 years, and they’re going to have the capital to make the decisions. Women care more, children care more, and they will control more and more of the capital. So, it’s now hard to imagine a world where sustainably focused companies in the industry don’t outperform companies that don’t care.


Listen to our podcast about impact investing here.


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