ESG investments and your retirement plan lineup

What is ESG investing?

Investment managers are increasingly applying    environmental, social, and governance considerations in addition to traditional financial factors as part of their analysis to identify risks and opportunities.

1. Environmental—The effect a company has on our environment and the effect our environment might have on the company. 
2. Social—The relationship between a company and its employees, consumers, suppliers, and communities.
   
3. Governance—The structures or systems a company uses—or is subjected to by its board of directors—to make sure there’s accountability, transparency, and trust.
   

Many investment managers that don’t manage funds with “ESG” in their label already integrate ESG criteria into their investment analysis. Therefore, it’s possible your members already have exposure to an ESG-integrated strategy through your current investment lineup.

Why are you considering ESG-specific investments for your retirement plan?

One of the first things you might want to consider is your reason for adding ESG-specific investments:

• Is it to enhance the competitiveness of your retirement plan? 
  
• Is it something your members have been asking for? 
• Or maybe it’s another reason?

Whatever your motivation, figuring out your “why” up front can help ensure everyone is on the same page before you start your due diligence.

If you haven’t checked if there’s demand for these types of investment options in your plan, you could do an employee survey to gauge interest. Ask about:

• Their satisfaction with the existing investment lineup
  
• How important it is for their investments to align with their personal values
• The likelihood they’d use the ESG fund if offered
• The likelihood they’d increase their contribution rate if an ESG fund was available
• Other types of investment options they may be interested in

The results of your survey will determine your next steps.

What approach could you take?

The next conversation could focus on defining your plan’s ESG investment approach. This approach can influence the funds your plan committee considers. 

Like with most styles of investing, there are different approaches or themes you can consider.

ESG integration and active ownership—ESG integration combines the analysis of ESG factors with traditional forms of securities analysis. This is the most common approach to sustainable investing and is widely practiced in actively managed funds. In addition, portfolio managers of these funds may seek to engage directly with company management teams to foster more sustainable business practices and may leverage their proxy voting rights to support shareholder resolutions or to register their views regarding corporate governance.  

Sustainability-themed investing—Investment strategies that may focus on specific themes, such as water conservation and scarcity or renewable energy.

Positive screening—The process of comparing companies within a given sector and targeting businesses with superior ESG standards versus their industry peers.

Negative screening—This can help investors put their money where they want to have an impact. Negative screening means excluding entire sectors, industries, or regions that score badly from an ESG standpoint. Negative screening can also take place at the company level, excluding certain companies that score below specific levels on ESG matters.

How could ESG-specific investments fit with your plan?

If you want to take a sustainability-themed, positive screening, or negative screening approach, the next step may be to think about how ESG-specific investments can fit with your retirement plan by doing a fit check:

• Do they fit with your plan’s objective?
  
• Do they fit with your plan’s investment policy?
• Do they fit with your capacity (governance, communication, etc.)? 

How do you incorporate ESG-specific investments into your lineup? 

There are different ways you can offer your members access to ESG-specific investments in their workplace retirement plans. 

There are many ESG mutual funds available in the marketplace with different investment strategies and objectives. To help you narrow down your choices, it’s important to remember that the ESG label doesn’t change your fiduciary duty. You’re still responsible for selecting prudent investments that are expected to perform reasonably well over time. This means you should follow the same documented process to pick your ESG funds that you use to choose your other plan investments.

What are the CAPSA guidelines? 

CAPSA released a draft guideline on Environmental, Social and Governance Considerations in Pension Plan Management in June 2022 outlining a set of principles on ESG factors in pension plan management and activities. The draft guideline covers:

• Fiduciary obligations 
• Implementation considerations for governance and risk management
• Disclosures

CAPSA has detailed three principles as guidance for pension plan administrators:

1. Pension plan administrators (either directly or through their delegates) should consider ESG characteristics that may have material relevance to the financial risk/return profile of the pension fund’s investments.
   
2. Plan administrators, as part of their standard of care, need to assess whether their plan governance, risk management, and investment decision-making practices are sufficient to identify and respond to material ESG information in a manner proportionate to their plans and appropriate for their investment beliefs.
3. Pension plan administrators should disclose in their SIPP information about the pension fund’s investment policies in relation to ESG considerations. Where appropriate, pension plan administrators should also provide reports on their stewardship activities as well as request companies in which they invest to disclose their ESG-related policies.

If you have questions about the CAPSA draft ESG guidelines, contact your financial advisor, who can help you understand the rules and select funds for your plan. 

What’s your member communication strategy?

If your organization  decides to add new funds to your lineup, you’ll need to notify plan members about the change in investment options per the CAPSA Guidelines for Capital Accumulation Plans. 

If you’re adding ESG-specific funds, it’s a good idea to couple this notification with some basic investment education that includes:

• An overview of ESG investing
  
• The potential benefits and risks of ESG funds
• And other factors your members might want to consider

This information can help your members better understand if ESG investments align with their long-term goals, risk tolerance, and investment preferences.