Articles | May 23, 2023

ESG in Retirement Plans: Investment, Risk Management and Regulatory Considerations

Environmental, social and governance (ESG) refers to the use of metrics and qualitative data on environmental, social and governance matters that inform the assessment of an asset. Led by investor demand, money managers’ incorporation of ESG has risen sharply in the past decade and a half. Increasingly, both DB and DC plans are integrating ESG considerations into their investment strategies.

Despite the mainstreaming of ESG, some states are passing laws and guidance intended to have a chilling effect on ESG integration by public sector plans.

ESG in Retirement Plans Investment Risk Management and Regulatory Considerations

In our new article published in the May/June 2023 issue of Benefits Magazine we review ESG trends and describe ESG challenges, policy debates and regulatory changes.

ESG integration

ESG integration means that an investment manager incorporates ESG data, along with traditional financial metrics, in the investment management process to enhance risk-adjusted returns. There is no inherent bar that stocks or other asset classes must surpass, but asset selection and management may be better informed by considering ESG data alongside traditional financial characteristics.

Studies generally find a positive correlation between ESG incorporation and financial performance. Most asset managers today use ESG integration in their approach, particularly with respect to the quality of governance of an investment.

ESG investing by retirement plans

Among DB plans, ESG incorporation generally varies by size and sector, with larger public and multiemployer plans having the highest level of adoption and smaller plans and private sector single-employer plans having a lower level of adoption. DB plans have incorporated ESG at a faster pace than DC plans in part because they invest in equities more frequently through separate accounts that hold individual securities, which gives them control over proxy voting and submission of shareholder proposals.

This pattern is likely to shift once the Department of Labor’s final rule on proxy voting and ESG takes full effect on December 1, 2023. The rule requires investment managers of mutual and other pooled funds in which DC plans often invest to vote proxies in proportion to each investor’s economic interest in the fund or require participating investors to accept the investment managers’ proxy voting policy prior to investing.

State limits on ESG

Despite federal support for the concept of ESG integration where the process is aligned to the economic best interests of plan participants, ESG faces challenges at the state level. In the past several years, public officials in several states have proposed initiatives or rules that would restrict public pension plans’ use of ESG factors.

Learn more

Our article also covers:

  • The many factors, definitions and measures related to ESG
  • Four mechanisms for ESG implementation by retirement plan sponsors
  • How ESG integration may be viewed as a set of mechanisms within a larger framework for managing risk

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The information and opinions herein provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. This article and the data and analysis herein is intended for general education only and not as investment advice. It is not intended for use as a basis for investment decisions, nor should it be construed as advice designed to meet the needs of any particular investor. On all matters involving legal interpretations and regulatory issues, investors should consult legal counsel.

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