The Jan. 10 ruling by U.S. District Court Judge Reed O'Connor said two American Airlines 401(k) plans violated ERISA's duty of loyalty through its relationship with BlackRock due to that company's advocacy of ESG principles in its public statements and proxy voting. Duty of loyalty requires sponsors to place participants' interests above corporate interests. The judge's ruling didn't address ESG funds because the plans don't offer them.
A T. Rowe Price survey showed a cooling of interest in ESG funds among consultants, although not necessarily integration of ESG principles. Published in September, the survey asked a series of questions in which a score of 4 represented “strongly agree” and a score of 1 was classified as “strongly disagree.” (Responses were collected from Jan. 12 through March 4.)
When presented with the statement “Evolving regulatory guidance and legislative developments are challenging,” the average score was 3.6 in 2024, compared to 3.1 for the same question in 2021. (The 2021 survey collected responses from Sept. 20 through Nov. 8 of that year)
“This is interesting as the DOL under the Biden administration offered a more accommodating stance on a fiduciary’s ability to consider ESG factors when making investment decisions compared to the prior Trump administration, which took a more restrictive view on ESG,” Sclafani said.
“Despite this, our research suggests that consultants and advisers have become weary of the back and forth, or ping-pong as it was referred to by many, which may serve to further depress the level of appetite for ESG funds,” she added.
The survey contained responses from 35 of the largest consultant and adviser firms with DC plan businesses in the U.S. with more than 134,000 clients and approximately $7.5 trillion in assets under advisement.
Another survey question illustrated declining optimism for ESG’s role in DC plans.
When asked if “ESG investing can increase enthusiasm for saving by aligning with participants’ ethical worldview and beliefs,” the respondents’ average score was 2.4 last year vs. 3 in the 2021 survey.
“This finding also reflects an increased weariness or ‘step back’ from potential implementation of ESG funds on DC plan menus,” Sclafani said.
A third question revealed consultants’ beliefs that adding ESG funds will be a tough sell for DC plan executives. Consultants were asked if “future research will validate ESG investing (and) demonstrate it can provide better returns and/or reduce risk.” The average score was 2.3 last year vs. 2.8 in 2021.
However, the survey also noted that “many DC plan fiduciaries agreed with the consideration of material ESG factors that can contribute to return or mitigate risk at the time we fielded this survey,” she added.
In fact, 71% of respondents in 2024 said the best way to introduce ESG to DC plans was through integrating ESG principles in their investment-selection process. “The distinction between ESG funds and ESG integration is important,” Sclafani said.
Low takeup rate
ESG funds haven’t gained much traction, according to annual surveys by the Plan Sponsor Council of America. The latest available data shows 6.2% of DC plans offered at least one ESG fund in 2023, according to the the most recent PSCA survey published in December with responses from 709 executives of 401(k) plans and combination 401(k)-profit sharing plans.
Between 2015 and 2023, annual surveys showed the percentage of ESG offerings ranged from 2.4% to 6.4%. For 2023, the average percentage of assets in ESG funds was less than 0.1% of total plan assets.
When asked why they didn't offer ESG funds, sponsors' biggest responses were: "haven't considered it" (42%); insufficient participant interest (27.1%); and unclear regulatory factors (21.2%).
In the PSCA survey, the largest plans (more than 5,000 participants) accounted for 15.5% of respondents. Plans with 1,000 to 4,999 participants represented 18.5%.
A survey of larger DC plans by Callan, published in April and covering the 2023 plan year, showed 15% of respondents offered an ESG fund while 9% were thinking about it. The survey covered 132 DC plans, with 32% having assets of $1 billion to $5 billion and another 32% having more than $5 billion in assets.
Record outflow
ESG trends also affected asset managers whose sustainable investing funds suffered a record outflow last year of $19.6 billion, according to an annual survey published by Morningstar Sustainalytics, a unit of Morningstar Inc.
The survey, which wasn’t restricted to the retirement industry, covers open-end mutual funds and exchange-traded funds. In 2023, outflows were $13.3 billion.
The survey’s report, published Jan. 16, attributed the outflows to these funds’ poor performance relative to conventional peers and high interest rates.
“High interest rates continued to penalize some areas of the market, such as clean energy stocks and other growth stocks,” the report said. “Only 42% of sustainable funds (were) in the top half of their respective Morningstar categories.”
Other reasons were a political backlash against environmental, social and governance investing, and greenwashing, the practice by which corporations’ ESG public-relations efforts exceeded their ESG actions.
Only 10 sustainable funds were launched last year, well below 2023 when 66 were launched and far behind the glory years of 2021 and 2022 when 116 and 103 funds respectively entered the market.
“The abrupt slowdown in product development can be directly explained by lower investor demand for new sustainable strategies in the ongoing ESG backlash context,” the report said.
Also last year, 71 sustainable funds were either merged or liquidated while 24 dropped their ESG-focused mandate, the report said. Both were records, representing the first time that fund closures and the dropping of ESG mandates exceeded new launches.
Last year also represented the first time the number of sustainable funds declined from a previous year. There were 587 open-end mutual funds and ETFs last year, down 9% from 2023’s record year.
Despite the outflows and shrinking market, overall assets of sustainable funds rose 6.3% to $344 billion last year, a product of market appreciation, the report said.
