Evaluating the role of ESG investments in your plan lineup
Environmental, social, and governance (ESG) investing has become mainstream as more people seek investments that can help them attain their financial goals while contributing to positive environmental and social change. This growing demand has prompted many plan fiduciaries to evaluate the role ESG investments could play in their plan lineup. Here are some key considerations to help guide your discussion.
Why are you considering ESG?
One of the first things you’ll want to consider is your motivation for adding ESG investments. Is it to enhance the competitiveness of your retirement plan? To address participant demand? A combination of both? Or something else? Identifying your motivation up front helps ensure your plan fiduciaries are on the same page before you start your due diligence.
What’s your ESG investment philosophy?
The next conversation should focus on defining your plan’s ESG investment philosophy. This philosophy will influence the ESG mutual funds and exchange-traded funds (ETFs) your plan committee considers. Like with most styles of investing, ESG strategies span a spectrum of approaches, including:
Exclusionary investment practice designed to screen out companies that offer harmful products or services (e.g., weapons, tobacco, alcohol, or gambling)
Investment strategies that may focus on specific themes, such as water conservation and scarcity or renewable energy
ESG integration and active ownership
The combination of ESG factors with traditional securities analysis; in addition, these strategies may seek to leverage their status as corporate shareholders to engage directly with company management or to effect change through proxy initiatives and/or direct dialogue
Have you assessed participant demand for ESG investments?
Seventy-five percent of individual and institutional investors consider a company’s social and environmental impact important to their investment decisions.1 You’ll want to make sure your participants fall into this group before adding ESG funds to your lineup. These funds can help participants attain their financial goals and make a social impact—but only if they use them.
An employee survey is one of the best ways to gauge interest. You can provide a brief explanation of your ESG philosophy and inquire about:
- Participants’ satisfaction with the existing investment lineup
- How important it is for their investments to align with their personal values
- The likelihood they’d use the ESG fund if offered
- The likelihood they’d increase their contribution rate if an ESG fund was available
- Other types of investment options they may be interested in
The results of your survey will determine your next steps. If there’s no demand, there’s likely no reason to continue the discussion. But if even a small percentage of participants express interest, you may want to evaluate the best way to address this need. Offering access to ESG funds to those who want them could help you build loyalty and retain talent.
What’s the best approach for incorporating ESG funds into your lineup?
There are generally three ways you can provide participants with access to ESG investments. One or more may be appropriate for your plan, depending on your objectives and other factors.
1 Self-directed brokerage account (SDBA)—Offering an SDBA would allow participants to select their own ESG investments based on their personal goals and ESG philosophy. Your plan fiduciaries would be responsible for selecting and monitoring the SDBA provider, but not the investments chosen by your participants. Given the added costs and complexity, you should work closely with your financial professional to determine if an SDBA makes sense for your plan.
2 Your existing plan investments—Many mutual fund and ETF managers have integrated ESG criteria into their investment analysis, so it’s possible your participants already have exposure to an ESG-integrated strategy through your current investment lineup. Communicating the tilt toward ESG investing within these funds could help you build goodwill with individuals who'd otherwise prefer ESG funds. Your financial professional can help you determine which plan investments offer this exposure and to what extent.
3 ESG-specific investments—There are hundreds of ESG mutual funds and ETFs available in the marketplace, with different investment strategies and objectives. To help you narrow down your choices, it’s important to remember that the “ESG” label doesn’t change your fiduciary duty. You’re still responsible for selecting prudent investments that are expected to perform reasonably well over time. This means you should follow the same documented process to pick your ESG funds that you use to choose your other plan investments.
Additionally, the U.S. Department of Labor (DOL) has issued proposed regulations that clarify how plan sponsors can incorporate ESG factors into the investment selection process. While you can’t rely on the regulations until they’re finalized (expected to be sometime in 2022), they do provide insight on the DOL’s perspective.
Any discussion about ESG investments should include your financial professional. They can help you identify the best ESG funds for your plan based on your ESG philosophy, investment policy statement, and objectives. They can also help you avoid investments that are ESG in name only, a concept known as green washing.
What’s your participant communication strategy?
If your plan committee decides to add ESG funds to your lineup, you’ll need to notify participants at least 30 days before the effective date. For example, if the ESG funds will be available starting June 1, you’ll have to send the notice no later than May 2. It’s a good idea to couple this notification with some basic investment education that includes:
- An overview of ESG investing
- The potential benefits and risks of ESG funds
- Factors participants should consider
This information can help your participants evaluate whether ESG investments align with their long-term goals, risk tolerance, and investment preferences.
What if your plan committee decides it’s not the right time to add ESG options? In this situation, consistent messaging will be essential. Consider providing your HR and benefits team with a standard response for participant inquiries. The response should be brief, emphasize the ongoing monitoring of the investment lineup, and offer other ways participants can get ESG exposure, such as the plan’s existing investments or SDBA, if applicable.
Add the ESG discussion to your next plan committee agenda
ESG investing has evolved over the past 20 years, growing from a niche market to a diverse landscape of strategies suitable for a wide range of financial and nonfinancial objectives. This evolution has afforded investors with more opportunities to align their investments and personal values without sacrificing performance. What does this mean for your retirement plan? That’s for your plan fiduciaries to decide by carefully evaluating the role ESG investments could play in your investment lineup.
1 “Advancing environmental, social, and governance investing,” Deloitte, 2020.
ESG investing risk. Incorporating ESG criteria and investing primarily in instruments that have certain ESG characteristics, as determined by the manager, carries the risk that the fund may perform differently, including underperforming, funds that do not utilize an ESG investment strategy. There is no guarantee that any investment strategy will achieve its objectives. Past performance is not a guarantee of future results.
The content of this document is for general information only and is believed to be accurate and reliable as of the posting date but may be subject to change. It is not intended to provide investment, tax, plan design, or legal advice (unless otherwise indicated). Please consult your own independent advisor as to any investment, tax, or legal statements made herein.
John Hancock Investment Management Distributors LLC is the principal underwriter and wholesale distribution broker dealer for the John Hancock mutual funds. Member FINRA, SIPC.
John Hancock Retirement Plan Services LLC offers administrative or recordkeeping services to sponsors and administrators of retirement plans. John Hancock Trust Company LLC provides trust and custodial services to such plans. Group annuity contracts and recordkeeping agreements are issued by John Hancock Life Insurance Company (U.S.A.), Boston, MA (not licensed in New York) and John Hancock Life Insurance Company of New York, Valhalla, New York. Product features and availability may differ by state. Securities offered through John Hancock Distributors LLC. Member FINRA, SIPC
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