Why are 401(k) Plans Not Aligned With Sustainability Goals?
As millennial-aged employees now represent the majority of the U.S. workforce, it is increasingly important that corporate management finds ways to engage them in the company. Creating 401(k) plans which connect to their core values — like solving human, social and environmental problems through their work and investments — can be a huge advantage to the company as a whopping 85% of millennials surveyed in the 2016 US Trust study said they consider their investment decisions as “a way to express their social, political, and environmental values.” This attracts the best talent, spurs employee engagement, extends retention, and sparks innovation.
Furthermore, adding Environmental, Social, and Governance (ESG) funds to an organization’s employee contribution plan enables a corporation to align its stated climate, environmental, social, and other sustainability policies,including adoption of U.N. Sustainable Development Goals (SDGs), and the U.N. Principles of Responsible Investing (UNPRI) with its investment options. The oft-heard phrase, “put your money where your mouth is” has never been truer or easier to implement.
Despite the growth of ESG-oriented funds in the wider investment market, the $8.4 trillion in U.S. corporate defined contribution plans do not reflect this growth and in fact have barely begun to include ESG funds in their portfolios. As an example, Vanguard reported that only 9% of its employee plans included ESG funds, most of which offered only a single fund rather than a suite of offerings. This discrepancy provides a tremendous opportunity for corporate plan administrators to align corporate values and sustainability goals with investments, while simultaneously enticing new employees, retaining existing ones, and increasing participation and contributions through a simple change in policy.
In terms of fiduciary duty, a recent 2015 Department of Labor ERISA guidance bulletin states that, “…environmental, social, and governance factors may have a direct relationship to the economic and financial value of the plan’s investment. In these instances, such issues are not merely collateral considerations or tie-breakers, but rather are proper components of the fiduciary’s primary analysis of the economic merits of competing investment choices.”
In terms of returns, since the 1970s, over 2,000 published studies have tried to understand the relationship between ESG criteria and corporate financial performance. A meta review by Sustainable Finance and Investment of this research compares ESG funds to traditional funds. 90% of all studies showed a non-negative relationship, indicating that inclusion of ESG factors did not affect performance. In fact, the majority of these studies reported a positive relationship, indicating ESG criteria improved market performance. According to a Bank of America Report, S&P 500 companies with high ESG ratings averaged 5% higher return on equity. And in terms of risk-avoidance, by investing in stocks with above average ESG ratings, an investor could have avoided 90% of company bankruptcies since 2008.
So, two major myths down. We see that there is no fiduciary risk and employees will not have a negative performance. So how does the company benefit? First of all, case studies show more employees will participate at higher levels. The addition of ESG and Fossil Free funds helped the architectural firm Stok increase its plan participation from 14% to 95% and average contribution rate from 1.6% to 7.1% in only two years. In a June 2017 Povaddo survey of employees inside Fortune 1,000 companies, 74% felt that having socially responsible funds offered through their 401(k) plans was important. This is consistent with the desire of employees, especially among millennials, to align their own value systems with those of their place of employment.
The benefits of adding ESG and Fossil Free criteria into company investment decisions and employee benefit plans include aligning with stated sustainability goals, reducing investment risk, and attracting and retaining the best talent. Essentially, employees, millennials in particular, seek to invest their retirement money in ways that will benefit the world in which they will live in the future. These value alignments keep employees focused and engaged with the business, driving real bottom line growth. Externally, investors are also increasingly looking to develop a portfolio that they believe is having positive impact on the future by aligning with the U.N.’s Sustainability Development Goals. The time has come for the private sector to demonstrate industry leadership and open the door to the internal and external benefits of incorporating ESG funds into defined contribution plans.
For more information download the As You Sow White Paper on this topic.