Why is ESG used most in retirement plans? It’s not performance

Institutional investors use environmental, social and governance factors to align with stakeholders, according to a report by Callan.

Institutional investors’ use of ESG criteria has nearly doubled since 2013 — though less than a third that use it say performance is one of their reasons.

Instead, environmental, social and governance factors are incorporated most often because of stakeholder concerns (60%) or to align with an organization’s values (53%), according to a report published Wednesday by Callan. However, 47% of respondents said they opted for ESG in part to improve their risk profile, and 44% cited fiduciary responsibility, according to the report, which is based on a survey in June and July of 102 institutional investors. Those investors included public and private pensions and defined-contribution plans, as well as endowments and foundations.

Just 28% of all respondents said ESG was added with higher long-term returns in mind, although rates were highest among private and public plans, at 38% and 41%, respectively.

Forty-two percent of respondents said they incorporate ESG in their plans, a figure that has changed little since 2018, but is nonetheless up from 22% in 2013, according to Callan.

Use of ESG was lowest in the corporate world, at 32%, compared with 36% among public plans, 63% of endowments and 57% of foundations, the report shows.

Those figures could change, given a recently proposed rule from the Department of Labor that could severely restrict the use of ESG investments in retirement plans. The DOL also proposed a rule for pension plans that would tamp down on proxy voting for issues not specifically related to financial performance.

Just as those proposed rules were being announced, the institutional investors surveyed hinted that they were much more likely to incorporate ESG than they were in the past. One third of the respondents without ESG in their plans said they were considering adding it in the future, a rate highest among endowments, at 67%, compared with 31% for corporate and public retirement plans and 33% among foundations, the report noted.

In 2019, 12% of those without ESG said they were considering it, while 15% said so in the 2018 survey and just 7% in 2017, according to Callan.

Among those that currently use ESG, more than half (56%) said that they consider ESG factors whenever they choose an investment manager. Further, 49% said they have hired a managed or approved an investment strategy that incorporates ESG, the report found.

More commonly, though, plans said they have added ESG language to their investment policy statement (60%).

In the DC world, ESG use remains low. While 26% of the DC sponsors surveyed said they have ESG options in their plans, that is roughly twice the rate seen in Callan’s much larger DC Index, which tracks trends and investments in such plans.

That figure is just 5% for private-sector DC plans, like 401(k)s, compared with 43% of public and nonprofit-sector plans, according to Callan. Less than 4% of all DC plans indicated they are likely to add an ESG investment option in the coming year.

Participants in such plans also opt for ESG at low rates, with an average of 1.2% of DC plan assets allocated to such funds, according to Callan’s DC Index.