Sustainable, responsible, and impact (
) investing is a growing part of the investment landscape.
Assets under management using SRI strategies now total $6.57
trillion, or $1 out of every $6 under professional management in
the U.S., and these numbers are growing.
Between 2012 and 2014, SRI investing grew by more than 76%.
A recent survey indicates that the majority of millennials
believe business can do more to address society's challenges in
the areas of climate change and resource scarcity.
This year Morningstar launched environmental, social, and
governance (ESG) scores for global mutual and exchange-traded
Despite the growing interest in SRI strategies, most
retirement plans such as 401(k) plans were slow to incorporate
ESG factors in the investment evaluation process. That may be
about to change. Last fall the U.S. Department of Labor (
) published guidance that seems to open the door to greater use
of SRI strategies in retirement plans. This guidance, in the form
of an interpretive bulletin, steps back from prior DOL guidance
that appeared to require plan fiduciaries to give economically
targeted investments (ETIs) special scrutiny not required of
other types of plan investments. While it is too early to tell
whether the DOL bulletin will lead to increased adoption of SRI
strategies by retirement plans, if you have clients or
prospective retirement plan clients who have expressed an
interest in SRI strategies, the new guidance provides an
excellent vehicle for reexamining this issue.
A variety of terms in addition to "SRI" are used to describe
an investment strategy that takes ESG factors into consideration
to select investments that will have both competitive financial
returns and a positive societal impact (e.g., socially
responsible investing, sustainable investing). The DOL uses the
term "economically targeted investments" (ETIs), which it defines
as investments chosen because of "the economic benefits they
create apart from their investment return to the employee benefit
Common types of investments include affordable housing, small
business development, community services (child care, health
care, education), job creation, expansion of existing businesses,
and support of sustainable development initiatives. ETIs appear
in a variety of forms including stocks, mutual funds, private
equity, real estate, and fixed income.
The "All Things Being Equal" Test
The first formal position the DOL took on SRI investing,
referred to by the DOL as ETIs, was in Interpretive Bulletin (IB)
94-1. In that bulletin, the DOL established the "all things being
equal" test. This test had three prongs.
- A plan fiduciary can never subordinate the interests of
plan participants and beneficiaries to a social purpose.
- The ETI must have an expected rate of return commensurate
to rates of return of alternate investments "with similar risks
available to the plan."
- The ETI must otherwise be an appropriate investment
considering the diversification of plan investments and the
plan's investment policy.
As long as plan interests were not subordinated and the ETI
could be expected to return a comparable rate of return as
investments with similar risks, a plan fiduciary could offer ETI
as an investment option. In effect, plan fiduciaries could use
ESG factors to break a tie with an equivalent non-SRI option.
Special Scrutiny Requirement Added in 2008
IB 94-1 remained the DOL's principal guidance on the topic
until it was replaced in 2008 by Interpretive Bulletin 2008-1.
The 2008 pronouncement put SRI strategies in a much less
favorable light as compared to the 1994 guidance. In the 2008
bulletin, the DOL said that consideration of non-economic, ESG
- Should be rare, and
- When an ETI is considered, the decision to invest should be
documented in a manner that demonstrates compliance with
ERISA's rigorous standards.
The 2008 bulletin seemed to require plan fiduciaries to give a
level of attention and circumspection to SRIs not required for
other plan investments.
DOL Restores & Enhances the "All Things Being Equal"
Recently, the DOL expressed its view that the 2008 bulletin
was unduly discouraging plan fiduciaries from investing in ETIs
or considering ESG factors, even when the investments were
economically equivalent.5 To address these concerns, the DOL
withdrew the 2008 bulletin and replaced it with IB 2015-01,
guidance more aligned with the position it had communicated in
1994. In its Fact Sheet released with the 2015 bulletin, the DOL
said that the "IB also acknowledges that in some cases ESG
factors may have a direct relationship to the economic and
financial value of the plan's investment."5 The DOL went on to
say that, "in such instances, the ESG issues are not merely
collateral considerations or tie-breakers, but rather are proper
components of the fiduciary's primary analysis of the economic
merits of competing investment choices."
The effect of the DOL's 2015 bulletin is significant.
- The three-prong test of IB 94-1 is restored.
- Plan fiduciaries do not have a "higher level" obligation to
scrutinize and document ETIs than they do for other plan
- ESG factors can be taken into account in determining the
economic benefit of investments and to find superior
Challenges & Opportunities
If you have retirement plan clients or prospective clients who
are interested in SRI strategies, IB 2015-01 provides an
excellent vehicle for discussing whether SRI strategies are a
good fit for their retirement plan's investment portfolio.
Following are some possible discussion points to include in your
Discuss whether your client wants to incorporate ESG
factors in their investment evaluation process
. Do members of the plan's investment committee believe that
ESG factors will materially impact the financial performance of
the plan's investments? Are there demographic and diversity
factors at play that will affect the decision to provide
ESG-driven funds such as a high concentration of Millennials?
Do members of the committee need additional education regarding
Evaluate how an SRI strategy would impact the
existing fund lineup
. How many investment options are currently provided to
participants? Where in the fund lineup would it make sense to
add an SRI strategy?
Consider how to integrate SRI beliefs and
expectations into the existing investment policy statement (
) and investment due diligence process
. Does the IPS need to be adjusted to incorporate ESG
considerations? Will there need to be any changes in the
process for selecting and monitoring the plan's investment
menu? Does the documentation retained by the investment
committee need to be modified or expanded?
These basic inquiries will be a good starting point for
discussing SRI strategies with plan sponsors. As with all
investment decisions, you play a critical role in helping your
plan sponsor clients define and pursue investment objectives that
are right for their plans.
Clients that elect to adopt an SRI strategy will need
your support to
- Define their investment objectives
- Develop or amend the IPS that sets out clear rules and
metrics for evaluating investment return and risk
- Identify and evaluate investment opportunities
- Review and evaluate SRI fund prospectuses
- Document the SRI decision-making process, as they do with
other plan investments
- Educate plan participants about SRIs
||US SIF Foundation,
Report on US Sustainable, Responsible, and Impact
Investing Trends 2014
The Deloitte Millennial Survey
, January 2014
||Morningstar, Inc. Press Release, "Morningstar
Introduces Industry's First Sustainability Rating for
20,000 Funds Globally, Giving Investors New Way to
Evaluate Investments Based on Environmental, Social, and
Governance (ESG) Factors," March 1, 2016
||Department of Labor, Interpretive Bulletin 2015-01,
October 26, 2015
||Department of Labor, Fact Sheet: "Economically
Targeted Investments (ETIs) and Investment Strategies
that Consider Environmental, Social and Governance (ESG)
Factors," October 22, 2015
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