Most DC plans believe ESG not yet ready for prime time

Investing in funds that focus on companies addressing environmental, social and governance factors apparently is not part of the New York state of mind — nor that of other defined contribution plans participating in Pensions & Investments' 2019 survey of the 1,000 largest U.S. retirement plans.

Of the 106 sponsors who responded to the question on whether they offer ESG investments, only 14 said yes.

One such plan, the New York State Deferred Compensation Plan, a $25.7 billion retirement plan for state employees, has offered an ESG fund in its investment lineup for at least 20 years, but few participants have invested in it. Through the end of December, only 1.6% of the plan's 245,000 participants were invested in the fund, allocating $38.1 million to it, just 0.15% of the plan's total assets.

"It is my best guess that participants want to maximize their returns," David Fischer, executive director of the plan, Albany, said of the modest uptake of the ESG investment offering. "Although ESG sponsored funds speak of excess returns, which may over some future term be true, it hasn't generally shown up yet."

Most defined contribution plan sponsors aren't willing to wait. In fact, most are not including ESG investment options in their lineups at all, fearing their perceived higher cost, lack of performance track record and potential fiduciary liability, industry practitioners say.

In a survey of 240 defined contribution plan sponsors last year, Alight Solutions found that only 7% offered ESG funds in their plan lineups, and the overwhelming majority — 89% — said they had no plans to add them to their lineups.

"While plan sponsors do care about ESG, they place a greater emphasis on performance and price," said Anna Fang, research analyst at Cerulli Associates in Boston, noting that sponsors are concerned about lawsuits.

Shawn O'Brien, a senior analyst also at Cerulli in Boston, added that because many ESG products are new they "don't have a long-term established performance record for which advisers and plan sponsors can go on to evaluate."

Plus, Mr. O'Brien said, ESG products are generally seen as more expensive than their non-ESG, plain vanilla passive counterparts.

The relatively few plan sponsors that do offer ESG investment options offer them through stand-alone "thematic" mutual funds or index funds, which are also less expensive.

The New York State Deferred Compensation plan, for example, offers participants the Pax Global Environmental Markets Fund, an equity fund that invests in companies working to address environmental challenges.

The New York plan has offered the fund since the third quarter of 2018. Before that, it offered the Pax World Balanced Fund, which was available since at least 2006.

The Pax Global Environmental Markets Fund has the highest expense ratio of all the funds offered in the plan's lineup, Mr. Fischer said. He added that the plan's investment adviser hasn't made him aware of any particular concerns with regard to the fund's performance results.

The Wisconsin Deferred Compensation Program, a $5.6 billion supplementary 457 defined contribution plan, likewise offers its 65,000 participants an ESG-focused index fund called the Calvert U.S. Large-Cap Core Responsible index, managed by Calvert Research and Management.

Through the end of December, some 3,300 plan participants had invested $67.2 million in the fund, 1.18% of the plan's total assets.

The plan has included a socially responsible fund in its lineup since 2003, according to Shelly Schueller, the program's Madison, Wis.-based director. The option has changed several times over the years "based on investment performance, which the board monitors regularly."

The fund had the highest expense ratio of all index funds in the plan's lineup but posted the greatest 10-year investment return, according to an investment performance report as of Sept. 30.

ESG investments are highly unlikely to be embedded into or packaged as a target-date fund, according to industry experts. "Most target-date providers aren't incorporating ESG into their target-date underlying strategies," Cerulli's Mr. O'Brien said. "Generally speaking, it's not usually being incorporated through a target-date approach or as a default investment."

Natixis, a pioneer in ESG target-date funds, is one of the few providers that incorporates ESG into its target-date funds, Ms. Fang said.

Plan sponsors, Mr. O'Brien said, tend to think that if participants want to invest in ESG products, they can do so through a brokerage window.

Of course, there are exceptions, among them the United World College-USA, a college founded by industrialist Armand Hammer in Montezuma, N.M. In July 2018, the college added an ESG target-date fund to its $3.4 million 403(b) plan and set the new fund as the default investment option.

The college's new LongView ESG target-date investments were built using custom model portfolios on TIAA-CREF's platform, said Douglas Lynam, partner at LongView Asset Management LLC, a registered investment adviser and ESG fiduciary based in Santa Fe, N.M.

The component funds of the LongView ESG TDF-like portfolios include three from Dimensional Fund Advisors L.P. – DFA U.S. Sustainability Core I; DFA International Sustainability Core 1; and DFA Emerging Markets Sustainability Core I. It also includes TIAA-CREF's Social Choice Bond Fund.

Mr. Lynam said he believed that the UWC 403(b) plan was the first to use a target-date ESG product and the first to use it as the default investment option.

"We're really proud of it," he said. "We hope it's a trendsetter."