United States: Impact Investing And 401(K) Plans: A Friendship In The Making?

For the fourth time over three administrations, the Department of Labor (DOL) voiced their cautions and views about fiduciaries using environment, social, and governance — or "ESG" — factors as a consideration in selecting investments for pension assets and 401(k) investment options. The guidance, summarized in our One Minute Memo, includes the following statement that encapsulates its views:

"Fiduciaries must not too readily treat ESG factors as economically relevant to the particular investment choices at issue when making a decision. It does not ineluctably follow from the fact that an investment promotes ESG factors, or that it arguably promotes positive general market trends or industry growth, that the investment is a prudent choice for retirement or other investors."

While the tone of the DOL's views sway with the tone of the administration, how do the current DOL's views reconcile with the changing investment landscape that is quickly and vocally understanding the impact of these "non-financial" factors on a company's long-term shareholder value and workforce? If you are watching from afar, there's an increasing divergence among the values of the largest segment of our workforce, mainstream investing, and the DOL.

The Background

First, a bit of context. ERISA and the Internal Revenue Code (the "Code") govern pension and 401(k) plans. The mere reference to ERISA and the Code can strike fear and consternation in fiduciaries who have oversight for the administration and investment of plan assets. The regulatory scheme is both complex and deep in history, and lends itself to conservative decision-making by fiduciaries.

As 401(k) plans continue to become the primary employer retirement vehicle, participants must decide for themselves how to allocate their contributions among the investment options. But, it is up to the fiduciaries to select the investment options that are offered to participants. It is long-established guidance that a mix of investment options must be given to allow participants to create a diversified portfolio to mitigate risk. This backdrop naturally gives way to a somewhat conservative and traditional view in selecting investment options.

ESGs: A Values Proposition?

But, another movement is gaining traction — investors are increasingly looking to align their values and money. Giving weight to ESG factors is one way of describing impact investing for the mainstream investment community.

Impact investing is an umbrella term that generally refers to making investments with an intent to generate both a financial return and a positive impact on environmental or social issues.

You may have also heard it referred to as socially responsible investing ("SRI") or socially conscious investing. It's basically considering ESG factors in investments and is grounded in the notion that financial returns do not need to be sacrificed at the expense of the environment, human rights, or other social issues, such as how and where materials are sourced, investing in programs that ensure a living wage, fair trade practices, and eradicating human trafficking (increasingly referred to as modern slavery) from the supply chain. These companies aspire to align profit-generating activities with a values-in-action approach to business.

This investment approach fits squarely with the values of millennials, who, at 56 million (or more) strong, now make up one-third of the workforce. Millennials seek meaning in their work and an alignment of their money and values.

A Competitive Edge

As employers seek to compete for top talent, benefits and incentives are always key recruitment and retention tools. Employers will want to right-size these tools to help shape their culture and further retention. A 401(k) plan that offers tax advantages and an employer match is a key retirement tool. As the impact investing world continues to be quantified and refined, and as the notion of this simple alignment of positive financial return and positive social impact resonates with a broader investment base, it will be a natural next step for employers to consider impact investment options in their 401(k) plans, which would appeal to the largest segment of our workforce.

The financial powerhouses of the investment world are recognizing that a focus on these non-economic factors are driving positive financial returns and are being responsive to the broader retail investor. For example, BlackRock CEO Larry Fink's open letter to CEOs is very much a call to action. In fact, in 2016, BlackRock began to offer the BlackRock Impact U.S. Equity Fund Investor A Shares, an impact investment portfolio. Charles Schwab offers a list of Socially Conscious Funds, derived from Morningstar. The notion of sacrificing returns is not a given with these funds or impact investors. There are an increasing number of organizations tracking, evaluating and measuring impact investments, including The Forum for Sustainable and Responsible Investment, the Global Impact Investing Network (GINN), and Morgan Stanley Institute for Sustainable Investing. Of particular note is the Impact Management Project, which is a multi-stakeholder project focused on the topic of impact measurement.

The DOL has not prohibited the consideration of ESG factors. There's a notion that impact investing is still new, which then raises the caution flags. But, as the impact investing world "matures," the cautions will relax. Fundamentally, if fiduciaries are adhering to best practices of good governance that include a diligent and rigorous process of evaluating its investment options from all angles, working with their advisors, and soliciting employee feedback, fiduciaries can enjoy the "best of both worlds." Some of the investment options can occupy a sweet spot of offering consistent market rate of financial returns alongside positive social impacts that powerfully appeal to their workforce and other stakeholders.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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