Applying ESG Principles to Employer Benefit Programs: Becoming the Standard Rather than Unique

In recent years, socially responsible investing has become increasingly important to companies and individuals alike. So much so that in 2019 alone, mutual funds and exchange-traded funds with a focus on sustainability raked in $20.6 billion of total new assets.¹

What has brought about this sudden surge in interest? There is growing evidence showing companies that consider environmental, social and governance (ESG) principles demonstrate that they care about more than just profit and operate in a socially responsible way. This was most notably recognized by the Business Roundtable last August, and it is because “doing good” is a behavior that is not only appreciated by all generations, genders and demographic groups, but is increasingly attractive to customers, employees and shareholders. Although much attention has been paid by companies deploying resources to better align their balance sheet assets with ESG principles, perhaps just as much attention should be placed on extending such principles to workplace benefits, including retirement plans.

The topic of ESG investing in retirement plans in particular has become increasingly popular as the Department of Labor (DOL) recently proposed a rule that would create stricter limits for ESG investing in these plans, raising several concerns by employers, including our own. The proposed rule, which fails to recognize the benefits that ESG investments can provide, would subject ESG factors to heightened restrictions that would expose ESG investors to additional liability and narrow the circumstance in which such investing would be permitted. What’s most noteworthy within the DOL’s proposal is the emphasis on investments as the definition for determining financial success within a retirement plan.

The concern here is that when it comes to retirement plans, success is more than the investment return, but rather the ability of the plan to ultimately fund the retirement of the employees that the plan serves. As such, perhaps a better approach for the DOL would be to focus on establishing ESG-specific standards, guidelines and practices. This includes helping companies to understand that ESG principles include not just investments but also success from the drivers of participation in a plan that makes the economic value possible, contributions to the plan that provide the initial capital and, ultimately, the investment choices that seek to increase the initial capital.

When it comes to ESG principles, the U.S. has some catching up to do. Not only are these standards more widely embraced globally in corporate governance than what we generally see in the U.S., but research shows that European-based ESG funds have outperformed conventional funds in various timeframes — one, three, five and 10 years.² What’s more, recent experience shows that ESG investments have historically outperformed broader markets, particularly in times of market stress. According to Morningstar, in March 2020, the MSCI World Index fell by 14.5%, but 62% of global ESG-focused large-cap equity funds outperformed the global tracker.³

Since retirement funds tend to require a longer-term investment strategy, many investors also believe that ESG principles will ultimately create greater value in the long run. In a recent paper, Starks et al. find that investors with longer time horizons tend to not only prefer ESG firms and investments but also that these individuals are less likely to sell in reaction to short-term events, suggesting the belief that ESG investments create value in the long run.⁴ Perhaps even more telling is the interest from individuals themselves. Recent research from Voya Financial found that the majority (76%) of individuals felt it was important for their employer to apply ESG principles to workplace benefits, with more than half (60%) noting that they would likely contribute more to an ESG-aligned retirement plan if it was certified.⁵

While many companies are realizing that ESG is not simply “going away,” many management teams are also realizing that adopting ESG principles could potentially be more valuable in the eyes of their shareholders. The reality, however, is that when it comes to investments, just 2.9% of 401(k) plans have even a single fund dedicated to environmental, social and governance issues, according to the Plan Sponsor Council of America.⁶ This is why it’s important for employers to consider not just investing but how all factors of ESG can be incorporated into a plan. Examples of this include the environmental aspects like eliminating paper, switching to e-delivery and encouraging digital engagement. The social, including increasing access to the plan through plan design, such as the inclusion of auto features and match structures, and a focus on plan governance, including value for the money and administration of the plan. When it comes to plan design, behavioral economist Professor Shlomo Benartzi of the UCLA Anderson School of Management notes that plan sponsors should consider the broader implications of ESG principals when designing and overseeing their retirement plans. For example, Benartzi says that “by adopting auto features, plan sponsors can dramatically reduce societal gaps in retirement savings behavior and help to improve retirement outcomes for lower income employees along with those other demographic groups that tend to save too little and too late.”

As both an industry and a country, there is much more that can be done to help advance all aspects of ESG, particularly as it pertains to diversity and inclusion from both a social and governance perspective. For companies, a clear way to make an impact is looking inside one’s company and to better understand how leaders and employees alike can make an impact. As more companies increasingly embrace ESG in their business models, it seems inconsistent to not also do so within their benefit plans to support their employees, ultimately becoming more of the standard than unique.

1, 2. & 3. Morningstar, “Sharpening the Tools of the ESG Investor,” (July 2020).

4. “Corporate ESG Profiles and Investor Horizons,” Laura Starks, Parth Venkat, and Qifei Zhu.
5. Voya “ESG Principles & Investing” study conducted through Voya’s Online Consumer Community with n=101 consumers balanced by age and gender (June 2020).
6. Plan Sponsor Council of America’s Annual Member Survey (December 2019).

This material is provided for general and educational purposes only; it is not intended to provide legal, tax or investment advice. All investments are subject to risk. Please consult an independent legal or financial advisor for specific advice about your individual situation.