Are ESG Funds a Good Fit for Your Retirement Plan’s Investment Menu?

May 7th, 2019
by Jonathan Leidy

Headline Image - Should You Include ESG Funds in Your Retirement Plan

Should You Include ESG Funds in Your Retirement Plan? Maybe, Maybe Not.

Environmental, Social and Governance funds (ESGs), can be appealing to many investors, particularly millennials. These funds may be viewed as a proactive way to encourage this often reluctant and under-prepared constituency to save for retirement. But is it a good idea to include ESG funds in your plan’s investment menu, at least in part, to entice investment “do-gooders” to boost their retirement savings? The short answer: It depends.

What are ESG funds?

Ethics-driven investment vehicles have existed since the 1970s. The first wave of these types of investments, Socially Responsible Investments (SRIs), sought to weed out companies that conflicted with investors’ values, including tobacco, liquor, gambling and munitions stocks.20190507 ESG Graphic

ESGs are the successors to those initial SRIs, and are often described as “socially conscious” investments— think companies purposefully using water more efficiently in their plants, firms with eco-friendly missions, or businesses setting up shop in underserved locations. And don’t forget corporate governance, an often-overlooked feature of ESG funds that includes practices like ethical behavior, fair executive pay and forthright financial reporting.

Evaluating ESG funds for your plan

Now that you know a bit about how ESG funds work, you may be wondering how to evaluate them effectively in the context of your investment selection process. Per the Department of Labor (DOL) bulletin, Interpretive Bulletin (IB) 2015-01, it begins with the data, i.e. do the funds in question have good fundamentals and are they “economically and financially equivalent” to other non-ESG funds on your menu?

In addition, there are third parties, like Oakland’s As You Sow, that rate the underlying companies in ESG funds based on their sustainability or ESG practices. Even investment information and data provider, Morningstar, offers a dedicated ESG data and research platform, which rates 20,000 funds worldwide.[1]

How about investment performance? There is a widespread perception that ESG factors may negatively impact performance.[2] However, some industry observers argue that incorporating in ESG factors results in enhanced risk-adjusted returns, because companies with sustainable practices tend to be stronger, better prepared for the future, and more appealing to consumers.[3]

ESG Funds: Yay or Nay?

Thus far, the DOL has been lukewarm on the use of ESG funds in retirement plans. Although there is no rule against using ESG options, the DOL’s bulletin cautioned plan fiduciaries not to put too much emphasis on the funds’ socially responsible missions as part of the investment selection and decision-making process. [4]

Due in part to the DOL’s cautionary guidance, the uptake of ESG funds in retirement plans has been slow — just 2% offered as an option as of 2016.[5] That said, the ESG fund universe is continuing to expand, as is investor interest, making it increasingly likely that this figure will mushroom over time.

If you are considering adding ESG options to your plan, make sure to do the following as part of your fiduciary responsibilities:

  • Amend your investment policy statement (IPS) to reflect any new ESG investing criteria
  • Make sure any ESG funds you select going forward adhere to the basic policies set forth in the IPS (i.e., those regarding fees, diversification, management, and track record)
  • Provide additional participant communication and education regarding the potential pros and cons of investing in ESG
  • Be sure to include ESG funds in your plan’s regular investment reviews

ESG may benefit the world by investing in companies with socially-conscious missions. However, whether ESG funds are beneficial for your plan and its participants is, ultimately, an important decision for your fiduciaries. Choose wisely.

[1] Morningstar. “Sustainable Investing: Surfacing ESG Data and Research.” 2018.

[2] Barney, Lee. PlanSponsor magazine. “GAO Explores Why Few Retirement Plans Embrace ESG Investing.” August 2018.

[3] Hartnett, Judy Faust and Moore, Rebecca. Plan Adviser magazine. “What Would Encourage More ERISA Plans to Use ESG Investments?” November 2018.

[4] DOL. ESG Investment Considerations. April 2018.

[5] Barney, Lee. PlanSponsor magazine. “GAO Explores Why Few Retirement Plans Embrace ESG Investing.” August 2018.