ESG investment options get little attention from participants in DC plans

Curbing a client's enthusiasm is not a role most financial advisers relish, but sometimes that's what they're called to do.

Such was the situation facing Mark Beaton, a retirement plan adviser with OneDigital Investment Advisors in Denver, as he tried to walk his client back from offering too many ESG investments in the organization's $6.6 million 403(b) plan. His client — a non-profit that helps generate scholarships for students looking to go to college — was unlike most clients in that it wanted to offer ESG investments and wanted to do so by giving plan participants not one investment option but 14.

Mr. Beaton, who serves as a vice president in OneDigital's retirement and wealth division with $103.7 billion in assets under advisement, listened as the client pushed to "basically double the investment menu" by having an ESG option for all asset classes.

"This might be a lot of overload," Mr. Beaton warned his client.

In the end, the client settled for offering the workforce two large ESG blend funds — the TIAA-CREF Social Choice Equity Fund and the Fidelity International Sustainable Index Fund — a decision that the client now realizes made more sense, Mr. Beaton said.

Since the non-profit added the funds to the investment menu six months ago, not a single participant has invested in the funds, even though employees had requested ESG fund options.

As ESG investing has become more popular, some employers — non-profits, in particular — have moved to add ESG options to their menus, but many are finding that there's little to no utilization. While advisers aren't sure why participant uptake is low, some posit that retirement savers simply don't have the time or interest to analyze investments in their 401(k) plans, even when they outright ask for ESG investments.

For that reason, Mr. Beaton advises clients to go slow. Rather than dive headfirst into ESG investing, he counsels clients to first dip their toes in the "ESG pool" with just one option to see if it's going to be utilized. Otherwise, it overcomplicates the investment menu and increases the work for plan sponsors and their fiduciaries in screening the funds.

"It's a lot more screening and discussions that need to happen around the menu," he said.

Joe DeBello, a managing consultant in OneDigital's retirement and wealth division in Orlando, Fla., has also gotten feedback from employers that their ESG funds have had little if any uptake from participants and relates to their frustration. After going through the effort of evaluating ESG investment options, it's leaving sponsors with an "is-it-worth-it type feeling," Mr. DeBello said.

The utilization of ESG funds indeed appears to be anemic, according to data from the Plan Sponsor Council of America's latest annual survey of profit-sharing and 401(k) plans. In 2020, less than one-half of 1% (0.03%) of total plan assets were invested in ESG funds, the survey found. The funds posted an average asset allocation of 0.1%, the lowest of any asset class.

More recent data from The Vanguard Group Inc. shows that in 2021, 6% of participants offered ESG funds used them, up from 3% in 2017, according to its latest How America Saves report.

While ESG investing has gotten a lot of buzz, advisers say demand among plan sponsors is also low, an observation supported by PSCA data. In 2020, 4.7% of plan sponsors offered ESG funds in their core menus, according to the PSCA.

Vanguard, however, shows higher plan sponsor adoption. In 2021, 13% of plans offered ESG funds, up from 9% in 2017.

Mr. Beaton said that while he's had two plan sponsors add ESG funds to their investment menus each year for the past two years, it's still "not top of mind" for most of his clients. The interest is mostly among non-profit organizations and to a lesser extent governmental entities, he said.

Greg Mykytyn, senior vice president with Commerce Street Peak Advisors in Dallas, also reports tepid plan sponsor interest in the funds. Of his 70 existing clients, only three have inquired about ESG investments.

Mr. Mykytyn, however, has seen an uptick in the number of prospective plan sponsors asking about ESG funds in their requests for proposals. About 15% of the RFPs he's working on inquire about ESG, up from about 1% that were asking in the period from 2016 to 2019.

Overall, though, he said he doesn't see ESG as an immediate concern or priority for plan sponsors.

"It's just not on the radar yet," said John Steiger, president and founder of Wealth Planning Resources LLC in Waltham, Mass., referring to DC plan sponsor interest in ESG funds. A few plans in the non-profit space have added them or want them but none, he said, are scrambling to implement the funds.

Eventually, Mr. Steiger believes ESG investments will become "more a part of the discussion," but for now, his plan sponsor clients are "not in tune with it."

The lack of demand stems from a variety of factors, not least of which is ambivalence among advisers. Mr. Steiger, for example, said he hasn't discussed ESG funds with his clients and "is glad he hasn't" because ESG funds lean toward technology stocks, which he notes "have taken a tougher hit than other stocks" in the current bear market.

Mr. Mykytyn, too, has reservations. He is troubled by the fact that the biggest proponents of ESG funds are active managers, who he said are trying to make up for the huge asset flows they've lost to more cost-effective passive fund managers. Mr. Mykytyn points out that ESG funds are more expensive than passive investments, costing investors 0.5% to 1% annually in retirement savings.

Mr. Mykytyn also cites the lack of sufficient ESG investment funds with a five-year track record, an investment requirement in 95% of investment policy statements. "Given that ESG has been thrown into the forefront in the past five years, not many of those funds will fit that criteria," he said.

For Mr. Mykytyn, whose standards are higher, the challenge of finding an appropriate ESG is even harder. "Five years isn't even good enough in my book," he said. "I want at least a 10-year or 15-year track record. I want to see that they've gone through a complete business cycle."

Mr. Mykytyn is also left scratching his head over the recent decision of the S&P Dow Jones Indices to drop Tesla Inc. from the S&P 500 ESG index and add Exxon Mobile Corp., a decision that he describes as "moving the goal post."

"Not even the proponents of ESG actually know what they're trying to do," he said. "I try to get all the smoke and mirrors out there. I want to take care of the environment just as much as anybody else, but trying to do this per the confines of ERISA, that's a very, very slippery slope and a dangerous path to go down."

Other advisers say the muted demand for ESG investments among most plan sponsors is due to the Department of Labor's flip-flop thinking on ESG, reversals reflecting changes in the White House administration. Plan sponsors are confused by the guidance, unable to determine whether the DOL thinks ESG is "good" or "bad" or "what they should and shouldn't be doing," OneDigital's Mr. DeBello said.

"There have been a lot of mixed messages," he said, adding that the topic has become somewhat of a "political football."

"I think the current political climate has folks on one side of the aisle blanketly dismissing the concept while others are embracing it," he said. "I think until we have crystal clear guidance from regulators, interest will continue to be muted."