Look Beyond the Label when Exploring ESG Investment Options | Lord Abbett
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Retirement Perspectives

Considerations for retirement plan advisors and sponsors on Environmental, Social, and Governance (ESG) values

Read time: 7 minutes

Environmental, social, and governance (ESG) funds hold strong appeal for investors based on their objective of helping the environment and promoting social good. Assets under management using ESG strategies grew to $17.1 trillion at the beginning of 2020, a 42% increase from $12 trillion in 2018.1  These funds may get a further boost due to the current administration’s stated interest in addressing climate change, thus providing a tailwind to ESG themes.

When it comes to including ESG funds in a retirement plan’s investment menu, what should plan sponsors consider?  In this paper we explore key ESG factors, including the labels, the current regulatory scene in Washington, and most importantly, the fiduciary impact on plan sponsors and their due diligence process.

First, what is ESG?

At a high level, ESG is investing that reflects personal values. ESG funds are portfolios of equities and/or bonds in which environmental, social, and governance factors have been integrated into the investment process. Equities and bonds in this type of strategy have passed stringent tests over how sustainable the company or government is regarding its ESG criteria.

 

Elements of ESG Investing

 

Plan participants gravitate toward ESG

A growing number of investors, especially younger plan participants, want to see their money go toward stocks or funds that are both profitable and reflective of their social values. As more members of Generation Z enter the workforce, demand for ESG investments will likely accelerate.

Including this type of investment option may yield positive plan activity. One study found that for those who said their plan did not offer ESG options, or did not know, 69% of respondents said they would or might increase their overall contribution rate if they were offered ESG options.2 Adding an ESG fund to a plan lineup can help demonstrate that plan sponsors are listening to the needs of their participants.

Regulatory flip-flops on ESG for retirement plans have our heads spinning

Plan sponsor interest in ESG funds is high, but mixed signals from regulatory authorities in the last few years have muddied the waters. Indeed, the Department of Labor (DOL) changed direction on ESG between administrations. This uncertain environment has made plan sponsors somewhat hesitant to commit to an ESG approach.

Previous rule met widespread resistance

Previously, the Trump administration had proposed a rule that would have made it more difficult for retirement plans to use ESG investments. This rule was widely opposed by providers, asset managers, consumer groups, and other stakeholders. An unprecedented 95% of the public comments the DOL received came out against it, calling the rulemaking unnecessary and antiquated in its hostile views on ESG investing.

The Biden administration announced that it would no longer enforce this rule until its DOL published further guidance. “There was no real rationale for that rule in the first place,” says Aron Szapiro, head of policy research for Morningstar. In fact, he said it was the opposite of what many investors want, with sustainable investments becoming increasingly popular every year.3

A proposed bill in the Senate, titled “Financial Factors in Selecting Retirement Plan Investment Act,” seeks to resolve the issue by repealing the 2020 DOL rule and clarifying that retirement plans may consider ESG factors in investment decisions.

DOL clarity is coming

In a key step forward, the DOL has submitted a new proposed regulation to the Office of Management and Budget (OMB) that would modify the regulatory framework that controls retirement plan fiduciaries’ actions related to ESG-themed investments. The OMB typically reviews proposed regulations within 60 days from the date of their submission or publication of the 30-day Federal Register notice—whichever is later—but, in some circumstances, the process can take longer.

Regulatory pundits believe the final rule itself may not explicitly refer to ESG as an investment theme that deserves additional scrutiny. Instead, it may well be that plan sponsors should use prudent factors they have always used when assessing investments of any type, in other words, only factors that have a material, demonstrable impact on performance.

ESG and performance

Speaking of performance, a focus on ESG does not necessarily have to sacrifice returns. Morningstar data shows an increasing correlation between ESG and financial performance. In a recent analysis, Morningstar found that funds that take ESG factors into consideration have actually outperformed other conventional funds, on average.

“After holding their own in the fourth quarter, sustainable equity funds finished 2020 with a clear performance advantage relative to traditional equity funds,” says Jon Hale, head of sustainability research for the Americas at Morningstar, in January. 4   Further: “There is no real conflict between good investment returns and promoting ESG practices,” says Morningstar’s Szapiro. 3

Don’t forget about the “G”

Stephen Dopp, National Director, Defined Contribution at Lord Abbett, recommends that advisors and sponsors look at each letter in the ESG acronym. “What’s interesting about ESG is that many people focus on the “E” and the “S” but not the “G”.  And the “G” is just as important,” he says. “For example, a fund manager may want to look at the composition of the board of a company and determine if there is diversity (or not). Or ask if the leadership of a company has a sustainable view on ESG.  There are many aspects of governance that may not seem wildly interesting but are tremendously important because they demonstrate that a company is doing more than just paying lip service to ESG ideals,” he says.

Interchangeable terms

With ESG, some terms have created confusion. ESG, Socially Responsible Investing (SRI) and Impact Investing are industry terms that have been used interchangeably, yet there are differences. What’s more, currently, there are no standard metrics for ESG investing.

 

Socially Responsible Investing and Impact Investing are other terms added to the mix.

 

What should retirement plan advisors and sponsors consider when evaluating asset managers?

Here are some things to consider as you hold conversations with asset managers:

  • What is their approach to ESG in general?  Do they embody the principles beyond their fund offerings?
  • Are they “greenwashing” their approach (where an investment company claims to be environmentally friendly but may not truly be)?  A strong ESG score may not mean what you think it means. “There is no agreed-upon definition of what ESG means, so funds may be marketing something that may not be in line with what a client wants,” says Matt Orsagh, Senior Director of Capital Markets Policy at the CFA Institute. 5
  • Are they building their own universe, or mimicking what other firms do? What specific screens does the asset manager employ? How do they adhere to their stated criteria?

Key fiduciary concerns for plan sponsors

Thomas E. Clark, Jr., a partner with the Wagner Law Group, specialists in ERISA and employee benefits, says that the complexities of ESG merit working with advisors and providers who are experts in this area.

 

“The first step for a plan sponsor in evaluating an ESG approach is to connect with an advisor and a provider who is well-versed in this area.”

— Thomas E. Clark, Jr., ERISA attorney

 

  1. Seek ESG expertise due to the complexities

Clark recommends that sponsors put a strong foundation in place at the outset by working with individuals and firms who are very knowledgeable on this subject. “The first step for a plan sponsor in evaluating an ESG approach is to connect with an advisor who is well-versed in this area,” he says. Why is this so important? “Not only is ERISA and retirement plans complicated already, and the fiduciary standards high, but when you go the ESG route, it raises a specter of risk because you are doing something outside the bell curve, so to speak,” Clark says. He adds: “This is important because the DOL is pretty clear that ESG funds have to pass the same scrutiny and screening as non-ESG funds.”

  1. Adhere to broader investment-menu objectives

“Step two is to evaluate ESG’s place and importance in your entire lineup, while offering a broad and diverse array of funds that satisfy your organization’s particular objectives. That means making ESG funds available along with non-ESG funds, not using just one or the other,” he says.

  1. Match investments to participant need

“Step three is to ask, “Are these the best and most appropriate funds for my people?” Clark says, likening this analysis to the process sponsors use when considering any other funds, such as target date funds. “Are they available? Do they meet the needs of my plan participants? And most importantly, does our fund lineup ensure that participants have the best opportunity for accumulating assets over their careers?”

 

Some of the best ESG investing choices may not even have ESG in their name.

Think beyond the labels for ESG funds. Ask if your provider infuses it into their entire process.

 

ESG checklist for plan sponsors

  • Seek expert help. Work with a retirement plan advisor who is well versed in this area. The ESG area is complex and wide-ranging. The advisor should be especially dialed into the regulatory scene.
  • Consider the philosophy outside of the fund. Consider providers who integrate ESG considerations into their entire investment process. ESG should be an entire philosophy that guides choices. “It’s infused into everything a good manager does, because they believe it contributes to overall improved performance,” says Stephen Dopp.
  • Look beyond the value of screens. Remember, not everything is incorporated into a Morningstar screen. Be sure to build in additional questions in your due diligence process when collecting data from asset managers related to ESG investing.
  • The litmus test. Ask if ESG factors are already “baked-in” to a manager’s viewpoint and are an important element of their buy/sell assessment.

How Lord Abbett approaches the issue

“At Lord Abbett, ESG is embedded into everything we do,” says Stephen Dopp. “We believe in the essential principles and bake this into our entire process and thinking.” He adds: “What’s more, we believe this philosophy gives us a broader, more authentic view of the investment universe and ultimately aids performance.”

We are a global corporate citizen

We believe that as a responsible global corporate citizen it is incumbent upon our organization to create positive impact.  How?  By allocating capital and engaging with companies based on returns and their actions concerning climate change, diversity, human rights, labor standards and poverty.

Lord Abbett’s ESG Strategy

Our approach consists of blending internal proprietary analytics and external ESG research from leading providers with the goal to deliver superior long-term, risk-adjusted, investment performance.

ESG philosophy

  • Our ESG efforts are guided by the principles of the United Nations 2030 Agenda for Sustainable Development; we are a signatory to the UN-supported Principles for Responsible Investment.
  • We believe that a responsible investment approach can result in positive impact beyond the return of a particular security, and that ESG integration can serve investors over the long term.

ESG investing process

  • We evaluate the impact of ESG risks and seek to ensure that the expected return is commensurate with those risks.
  • At Lord Abbett, we expect that consideration of ESG factors will lead to alpha opportunities, as we believe companies that provide solutions to ESG issues have the potential to offer higher, risk-adjusted returns.

ESG engagement

  • To us, active ownership means engaging directly with company management to understand, influence, or exchange perspectives on ESG issues.
  • We seek to identify companies with strong corporate governance and to avoid adverse effects of poor environmental and social practices.

 

Fund spotlight: Climate Focused Bond Fund

* As of 12/31/20

** PRI is Principles for Responsible Investment. The PRI assessment is not an overall organizational score.
Please refer to Impact Through Strategic Industry Partnerships for more information on the PRI Assessment Report.

*** 2019-2020 Proxy season (July 1, 2019 - June 30, 2020).

† Based on analysis of asset managers with at least $100 billion in assets under management and voting at least 50 proposals each year.

‡ Percentages are not an indication of how well each asset class scored in ESG Risk Ratings, but simply the percentage of securities that have been assigned a risk rating. As of 12/31/20.

 

Talk to us.  We’ll help you weigh the considerations.

We work with our research analysts and portfolio managers to fully integrate ESG factors into our engagement efforts and investment decision-making process. We’ll help plan advisors and sponsors walk through what’s important.

To learn more, talk to your local Lord Abbett Regional Manager, or call us at 888-522-2388.

 

 

A Note About Risk:  The Fund is subject to the general risks associated with investing in debt securities, including market, credit, liquidity, and interest rate risk. The value of your investment will change as interest rates fluctuate and in response to market movements. When interest rates fall, the prices of debt securities tend to rise, and when interest rates rise, the prices of debt securities are likely to decline. The Fund is subject to the risk that its climate-focused investment strategy may select or exclude securities of certain issuers for reasons other than investment performance considerations which may negatively affect its performance relative to unconstrained peers. Certain climate-focused investments may be dependent on government policies and subsidies, which are subject to change or elimination. The Fund may invest in high yield, lower-rated debt securities, sometimes called junk bonds and may involve greater risks than higher rated debt securities. These securities carry increased risks of price volatility, illiquidity, and the possibility of default in the timely payment of interest and principal. The Fund may invest in non-U.S. or emerging market securities, which may be adversely affected by economic, political, or regulatory factors and subject to currency volatility and greater liquidity risk. The Fund may invest in derivatives, which are subject to greater liquidity, leverage, and counterparty risk. The fund performance history at this time is very limited; therefore, performance achieved during its initial period of investment operation may not be replicated over longer periods and may not be indicative of how the Fund will perform in the future. These factors can affect Fund performance.

New Fund Risk: The Fund is newly organized. There can be no assurance that the Fund will reach or maintain a sufficient asset size to effectively implement its investing strategy.

Performance data quoted is historical. Past performance is not indicative of future results. Current performance may be higher or lower than the performance quoted. The investment return and principal value of an investment in the Fund will fluctuate so that shares, on any given day or when redeemed, may be worth more or less than their original cost. To obtain performance data current to the most recent quarter-end, go to quarter ending performance on our Website or call Lord Abbett at (888) 522-2388.

Investors should carefully consider the investment objectives, risks, charges, and expenses of the Lord Abbett Funds. This and other important information is contained in the Fund's summary prospectus and/or prospectus. To obtain a prospectus or summary prospectus on any Lord Abbett mutual fund, contact your investment professional, Lord Abbett Distributor LLC at 888-522-2388 or visit us at lordabbett.com. Read the prospectus carefully before you invest.

 

Lord Abbett mutual funds are distributed by Lord Abbett Distributor LLC, member FINRA.

 

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett's products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.

 

 

1 2020 Report on US Sustainable and Impact Investing Trends, US SIF Foundation

 

2 Umpierrez, Amanda, “Plans with ESG Options See Larger Contribution Rates,” PLANSPONSOR, May 13, 2021

3 Adamczyk, Alicia, “The Department of Labor is making it easier to invest in ESG funds in your 401(k), CNBC, March 11, 2021

4 Kline, Maureen, “Bringing Retirement Plans into the ESG Revolution,” Worth, March 19, 2021

5 Rose Smith, Imogen, “The Inconvenient Truth about ESG,” bnymellon.com, May 2020

MORE ON ESG
 

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