ALIGNING RETIREMENT ASSETS TOOLKIT #1 - The responsible retirement plan opportunity - WBCSD
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ALIGNING RETIREMENT ASSETS TOOLKIT #1 The responsible retirement plan opportunity
Content
1 Introduction | 4
About this project | 5
2 Corporate retirement plans overview | 7
A. Types of retirement plans | 8
i. Defined benefit (pension) plans
ii. Defined contribution plans
iii. Hybrid structures
B. Retirement plan governance and administration | 10
i. Retirement plan or benefits committee
ii. Retirement plan administrators
iii. Investment managers
iv. Advisors, recordkeepers and other service providers
v. Insourcing vs. outsourcing
C. Fiduciary duty | 14
i. Defining fiduciary status
ii. Complying with fiduciary duty requirements
3 The responsible retirement opportunity | 18
A. What is a responsible retirement plan? | 19
i. Overview of responsible investment approaches
ii. Overview of responsible investment methods
B. Context for the implementation of
a responsible retirement plan | 22
i. Regulatory landscape
ii. Data issues
iii. Empirical evidence
C. How could responsible retirement
plans impact fiduciary duty considerations? | 28
i. Duty of loyalty
ii. Duty of prudence
iii. Duty to diversify
below50 | Insights Report 3
1
Introduction
Responsible investing, which involves taking a
longer-term and broader perspective on environmental,
social and governance (ESG) risks and opportunities
compared to traditional investment approaches, has
been shown to potentially lead to positive investment
outcomes over the long-term.
44 Aligning
Aligning Retirement
Retirement Assets
Assets || Toolkit
Toolkit #1
#1
1 Introduction
Due to the enhanced prospects younger ones – tend to save The goal of this project is
of outperformance, as well as more for retirement when to improve outcomes for
ancillary benefits, responsible offered investment options that retirement plan beneficiaries
investment is an area of increasing reflect their values.1 Spurring by lowering barriers to the
interest among institutional such employee engagement is adoption of responsible
investors as well as the general of interest to employers of all retirement practices through
public. Reflecting the growing types, however developing and education, dispelling myths
awareness that responsible implementing an effective and about responsible investing and
investment could lead to better durable responsible retirement empowering engaged employees
investment performance of plan requires both dedication and to better understand their
retirement plan participants’ a careful, thoughtful approach. possible options to begin saving
and beneficiaries’ assets, and for retirement responsibly. While
often driven by employee interest, As we will discuss in more detail, the process of implementing a
a growing number of employers retirement plans around the world responsible retirement plan may
have been evaluating how to are highly regulated, which means not be a quick and easy one, this
integrate responsible investment that making any changes to project aims to help make the
approaches into the retirement investment processes to integrate process as straightforward and
plans they offer. ESG considerations will likely take transparent as possible.
multiple quarters, if not years, to
Some employers who have implement. This project is structured in two
successfully integrated phases, centered around the
responsible investments into publication of “toolkits” that seek
their retirement plans have found to provide practical information
that employees – particularly about responsible retirement.
About this project
In June 2018, the World An additional benefit of Our collaboration partners
Business Council for this work is that it may help – including Allianz Global
Sustainable Development retirement plan sponsors to Investors, BlackRock,
(WBCSD) launched “Aligning meet a growing demand for Legal & General Investment
Retirement Assets” (ARA) sustainable investments and Management, Mercer,
as part of its Redefining increase plan engagement, Natixis and the Principles for
Value program. The goal of participation and savings Responsible Investment –
this project is to encourage rates. Furthermore, plan have joined the ARA steering
responsible retirement sponsors have an opportunity committee to contribute best
plan investments since to reflect and extend the practices and innovative
thoughtfully considering underlying company’s core thinking on ESG, while helping
ESG factors in investment values and commitment to to educate member companies
processes can result in sustainability by making on incorporating responsible
improved risk-adjusted investment decisions strategies in their retirement
returns for participants and informed by ESG factors, plans.
beneficiaries over the longer without compromising returns.
term.
1
As You Sow (2017). “Aligning Defined Contribution Plans with Sustainability Goals.” Retrieved from https://static1.squarespace.com/static/59a706d4f5e2319b70240e-
f9/t/5a72904d53450a892aa6c4bd/1517457487290/401k-White-Paper_20171027.pdf. Pensions & Investments (2018). “Millennials embrace ESG option in Bloomberg’s 401(k)
Aligning Retirement Assets | Toolkit #1 5
1 Introduction
We hope that you will find this first toolkit useful
Toolkit advancing your company’s efforts to align its
retirement assets with responsible practices.
#1 #2
(to be released in early 2019)
is an introduction to
will provide a more “tactical”
retirement plans and how
approach to responsible
responsibility might be
retirement plans, with a
considered in different plan
strong emphasis on helping
structures and contexts.
interested individuals start
The purpose of this toolkit to have conversations with
is to answer the question the right people internally,
“What is a responsible as well as a series of typical
retirement plan?” starting objections that individuals
with the basics of how might encounter and ways to
retirement plans are respond effectively to them.
governed and operated.
This toolkit will answer the
question “How can we
develop and implement
a responsible retirement
plan?” and will feature case
studies highlighting what
other companies have
achieved.
6 Aligning Retirement Assets | Toolkit #1
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#1 77
2 Corporate retirement plans overview
2
Corporate
retirement
plans overview
The following sections introduce the basic structures
and legal requirements underpinning corporate
retirement plans, in the interest of educating readers
whom may be new to the subject.
88 Aligning
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Assets || Toolkit
Toolkit #1
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2 Corporate retirement plans overview
A. Types of retirement plans
There are significant differences i. Defined benefit (pension) ii. Defined contribution
among retirement plan plans: plans:
structures, and these structures
determine the considerations Defined benefit (DB) retirement Defined contribution (DC)
plans guarantee, or “define” the plans guarantee, or “define”
employers consider in their
benefits that plan participants the contributions that plan
approach to offering retirement
can expect to receive upon participants can expect
benefits. A key differentiator their retirement. Typically, employers to make into a
among plan types concerns benefits are calculated according retirement account on their
who, whether the plan sponsor to a formula that takes into behalf. In such a structure, the
or the plan participant, bears account years of employment employer will frequently guarantee
the investment risk associated and salary level, usually providing to “match” an employee’s annual
with making investments. a percentage of the past three contribution to their DC account
A common component of to five years average annual up to a certain percentage of their
virtually all retirement plan salary to beneficiaries upon salary or total dollar amount, thus
types is that employers will retirement. In a DB plan structure, providing incentive for employees
make contributions to employee plan sponsors typically invest to save. Furthermore, employers,
on their participants’ and as plan sponsors, will work with
retirement funds as part of
beneficiaries’ behalves with the investment advisory firms to
total compensation packages,
aid of an investment advisor, or determine the number and variety
and frequently employees will they outsource the investment of different funds to offer to their
contribute a portion of their process to a third party. employees as investment options
monthly income as well. within their plan’s “lineup.”
DB structures generally force
employers to assume the DC plan structures therefore
investment risks for investing offer no guarantees regarding
on behalf of plan participants, the future benefits that plan
given that the benefits are defined participants can expect from
by contractual agreement when their retirement savings,
employees are hired, regardless placing the responsibility on
of investment performance or plan participants to save and
market conditions. As these invest their money wisely, while
future benefit payouts to retirees also requiring participants to bear
represent significant balance investment risk. In contrast to DB
sheet liabilities, many employers plans, DC plan structures only
have closed their DB retirement require employers to account for
offerings to new employees retirement plan contributions as
in favor of offering defined future balance sheet liabilities,
contribution plans, however these thus reducing the uncertainty and
trends differ significantly between risks employers are exposed to as
regions. plan sponsors.
Aligning Retirement Assets | Toolkit #1 9
2 Corporate retirement plans overview
iii. Hybrid structures:
Beyond traditional DB and DC plan A brief overview of some hybrid shift in who bears the investment
structures there exist a range of structures and their key features risks and the treatment of benefits
other “hybrid” retirement plans follows. The key differentiators accrual.2
that combine features of both to between these options are the
varying degrees.
Figure 1: Different retirement plan types and characteristics
INVESTMENT RISK
EMPLOYEE EMPLOYER
DC DC w/ DB DB w/ DC Cash balance, pension
equity, DB
CASH PENSION
PLAN FEATURE DC DC WITH DB DB WITH DC DB
BALANCE EQUITY
Employee Employee
(possible (possible Employer and Employer and Employer and Employer and
Funding source employer employer employee employee employee employee
contribution) contribution)
Portable to new
Yes Yes Some Yes Yes No
employer
Responsibility for Employee and Employer and Employer (until Employer (until
Employee Employer
investment risk annuity provider employee separation) separation)
Rate of return for Guaranteed Guaranteed Guaranteed
employee during Variable Variable Mixed for employee for employee for employee
service contributions contributions contributions
Part even
Front loaded, Front loaded, Back loaded,
Accrual of and part back
toward start of toward start of Even Even toward end of
benefits career career
loaded, toward
career
end of career
Yes, unless No, if service
Potential to No, if annuity No, if annuity No, if annuity
annuity requirement No
outlive funds purchased
purchased
met
selected selected
Source: Robert L. Clark, John J. Haley, and Sylvester J. Schieber, “Adopting hybrid pension plans: financial and communication
issues,” Benefits Quarterly, First Quarter 2001, pp. 7-17.
Source: Mercer, NASRA
2
For more information on hybrid retirement plan types, please see: https://www.nasra.org/Files/Topical%20Reports/Hybrids/Hybrid-primer.pdf.
10 Aligning Retirement Assets | Toolkit #12 Corporate retirement plans overview
B. Retirement plan governance and administration
Understanding how retirement i. Retirement plan or benefits Investment Policy Statement to
plans are governed and committee:3 guide the plan’s investments,
administered within a company monitor investment
is an essential element of Plan committee members performance, and hire and
are charged with the overall assess the performance of
uncovering opportunities to
governance of a retirement third-party vendors to the
advance sustainability within the
plan and setting the plan’s plan, including the advisor,
plan. The following points are long-term direction. Certain recordkeeper, and others.
representative descriptions of members of the committee are As part of the fiduciary duty to
the role each body or individual frequently the heads of various diversify, DC plan subcommittee
plays in governing and/or key divisions within the plan members must ensure that the
administering the retirement sponsor company, such as the selection of investment options
plan, although note that the heads of the human resources, available to plan participants
specific titles of retirement plan legal, and finance divisions within is appropriately broad across
boards/committees/individuals the firm, although many plan asset classes and categories.
may differ by plan. committees have members who This subcommittee generally
are plan participants, retirees (i.e. will provide instructions for
beneficiaries of the plan) or are the plan sponsor’s finance,
independent. Plan committees investments staff or third-party
often adopt committee charters service providers to enact.
that formalize the committee’s
structure, mission and duties, b. Administrative subcommittee:
as well as establishing rules that This sub-committee generally
stipulate the committee meeting oversees the plan’s
schedule, record retention interaction with government
policies, etc. regulators, plan participants/
beneficiaries and third-
a. Investment subcommittee: party vendors. Frequently this
Many retirement plan subcommittee will establish the
committees will establish rules and procedures for how
a separate Investment participants and beneficiaries
Committee that oversees may make claims against
the investments made by the the plan, determine eligibility
retirement plan (for DB plans) and access plan educational
or the lineup of investment materials. This subcommittee
vehicles that the plan offers to generally provides guidance
participants (for DC plans). This and instructions for the plan
committee is often populated sponsor’s human resources
by officers and employees of staff to enact.4
the plan sponsor who have
financial expertise, and the
committee may, among other
things, develop and adopt an
3
For benefits, this assumes committee members are responsible for other benefits beyond retirement such as medical/wellness plans.
4
Investment and admin committees are often combined. Other committee titles sometimes used include DC committee, pension committee, 401k committee (in the US), etc.
Aligning Retirement Assets | Toolkit #1 112 Corporate retirement plans overview
Figure 2: Representative diagram of retirement plan governance structure
Corporate BOARD
Governance OF DIRECTORS
Management Rep. CFO / CHRO /
or Committee Chair TREASURER
Retirement Plan Retirement Plan
Governance Tier 1 Committee (DB/DC)
Retirement Plan INVESTMENT ADMINISTRATIVE
Governance Tier 2 COMMITTEE COMMITTEE
Retirement Plan PLAN SPONSOR INVESTMENT PLAN SPONSOR RECORDKEEPER,
Administration STAFF CONSULTANT STAFF OTHER
Source: Mercer
ii. Retirement plan iii. Investment managers:
administrators:
These firms manage the diversify noted above. For both
Frequently comprised of the staff investments entrusted to them DB and DC plans, the investment
who work for the CFO/CIO and/or by plan sponsors (in DB plans) manager selection and monitoring
Chief Human Resources Officer and participants (in DC plans). process is an essential element
(or officers with similar titles) Investment managers offer funds of fiduciary duty with respect to
these administrators carry out that provide investors exposure to plan management, ensuring that
the directions provided to them securities of different asset classes managers’ performance is meeting
by the retirement plan committee and categories, such as global or exceeding expectations, the
and subcommittees. Given they equities, or investment grade fixed investment team/process remains
have day-to-day oversight of the income (i.e. corporate bonds). consistent, etc. Fiduciaries
retirement plan(s) being offered by DB plans will invest with different may elect to shift the plan’s
a company, these administrators managers to achieve plan goals for investments away from managers
can be excellent sources of performance and diversification that consistently underperform,
information regarding the details across the investment portfolio, have fees that exceed those
of the plan, its institutional history among other goals. DC plans will of competitors or if other plan
and additional context around select different managers across circumstances change (e.g.
the particular views of key plan asset classes and categories liabilities increase, participant
decision makers and stakeholders. to offer to plan participants to expectations change, mergers and
invest in, in line with the duty to acquisitions occur).
12 Aligning Retirement Assets | Toolkit #12 Corporate retirement plans overview
a. Qualified Default Investment iv. Advisors, recordkeepers b. Recordkeepers: as the name
Alternative (QDIA): a key and other service providers: suggests, recordkeepers
element of DC plan investment track key administrative
lineups is offering a QDIA to plan Retirement plans typically engage information about a retirement
participants, which is a fund that a range of third parties who plan: determining eligibility to
a participant’s retirement savings provide important services to participate, enrollment tracking,
are placed into when that the plan to ensure it is fulfilling its participant investments
individual has not selected other fiduciary duty to participants and tracking (for DC plans) and
funds for investment. Given beneficiaries. plan withdrawals, among
that a significant proportion other functions. In addition,
a. Investment advisors: plan
of plan participants may leave recordkeepers maintain the
sponsors (led by administration
their investments in the QDIA, website and customer service
staff and/or committees)
fiduciaries must ensure that portals where participants can
typically hire an investment
these funds are appropriately log in to track their account
advisory firm to provide advice
diversified to reduce the risk of information, so they play an
on the investment selection and
loss. Investment managers have important role in ensuring
monitoring process on a regular
developed a range of QDIA- participants are informed
basis. Tracking the performance
qualified products that satisfy and educated regarding their
of investment managers and
those requirements. Asset retirement plans.
researching their capabilities
class products structured to
– typical advisor services – are
reflect an appropriate asset
specialized tasks which most c. Other service providers:
allocation for a participant’s
plan sponsors do not have the depending on the size and/or
age and expected date of
capacity to conduct internally. complexity of the retirement
retirement. For example,
Gaining such outside expertise plan, plan fiduciaries may
younger participants will tend
is also generally interpreted elect to engage other outside
to have more aggressive
as being consistent with the service providers, including
asset allocations with a
fiduciary duty of prudence as it benefits consultants, lawyers,
higher proportion of equity
provides decision makers with accountants or actuaries. Such
investments, while older
objective third-party information entities may provide important
participants’ TDFs will be shifted
regarding investment options services to retirement plans
towards a higher proportion of
and supports the selection of yet are less commonly hired
fixed income investments that
appropriate investments for the than are recordkeepers and
offer stable income, albeit with
plan. Given their role as experts, investment advisors.
lower return potential.
investment advisors play an
important role in helping plan
fiduciaries consider the risks
and opportunities of various
investment options, and in
ensuring that fiduciaries are
informed of relevant market
developments.
Aligning Retirement Assets | Toolkit #1 132 Corporate retirement plans overview
v. Insourcing vs. outsourcing
Plan sponsors engage with third-
party service providers in a variety Expanding the in-house team
with greater use of third-party
In-house
of different ways. As stated above,
team
research and tools but full
one of the most important in-house implementation and
relationships plan sponsors ongoing evaluation
maintain is with their investment
advisor. Traditionally advisors have
provided plan sponsors with advice
on their portfolio asset allocation
(DB), lineup construction (DC) and
manager selection/monitoring
Greater use of traditional
Investment
(both) and plan sponsors have
investment consultants
advisory
maintained the responsibility for for advice on strategy and
implementation of investment research but full in-house
portfolios and managing other implementation
third-party relationships (e.g.
recordkeeper). Though today the
nature and extent of this advice
can vary substantially, up to and
including a fully outsourced model.
A description of the various modes Use of third-party manager
of advisor engagement for plan selection platforms for
Manager
platform
sponsors follows. operational implementation
but retaining all investment
decisions, including manager
selection
Partial outsourcing to
provider for operational
outsourced
implementation as well as
Partially
selective investment decisions
such as manager selection,
dynamic asset allocation and
liability-driven investment
design and implementation
Full outsourcing to
provider for all operational
outsourcing
implementation as well as
investment decisions following
Full
strategy and risk budget
setting, sometimes called
OCIO or Delegated Manager
Source: Mercer
14 Aligning Retirement Assets | Toolkit #12 Corporate retirement plans overview
C. Fiduciary duty
The term “fiduciary” derives i. Defining fiduciary status: • Fact-based: where
from the Latin fides, meaning the particular facts and
In the United States corporate circumstances of a relationship
“trust,” or “faith,” and in the
retirement plan context, “[u]sing clothe it in a fiduciary character…
sense of a financial relationship, discretion in administering
means “held or founded in trust the presence of the following
and managing a [retirement] factors may give rise to a
or confidence.”5 Fiduciaries plan or controlling the plan’s
fiduciary relationship:
are individuals, or entities, who assets makes that person a
act on behalf of others in their fiduciary to the extent of that A. An undertaking to act on behalf
management of financial affairs. discretion or control”7 according of or for another person;
At their core, fiduciary duties to the United States Department
of Labor, the federal retirement B. A discretion or power to act
“ensure that those who manage which affects the interest of
plan regulator. In this sense, all
other people’s money act in the individuals making decisions that other person;
interests of beneficiaries, rather regarding the administration of C. The peculiar vulnerability of
than serving their own interests.”6 the retirement plan, as well as all that other person, shown by:
individuals serving on a plan’s
It is essential to understand the administrative committee (if the i. Dependence on information
responsibilities of fiduciaries plan has such a committee) will be and advice;
because virtually any action considered fiduciaries from a legal
that a corporate retirement and regulatory standpoint. ii. A relationship of confidence; or
plan sponsor takes in relation
In the United Kingdom, the Law iii. The significance of a
to its retirement plan is subject
Commission defines the fiduciary particular transaction.8
to scrutiny by regulators, and
therefore retirement plan relationship in two ways:
fiduciaries continually consider While these two countries offer
• Status-based: where a
their responsibilities under the law. slightly different approaches to
relationship falls under a
defining fiduciaries in law, the
previously recognized category,
following graphic summarizes how
such as a solicitor and client,
trustee and beneficiary, and fiduciaries are typically defined in
agent and principal; or practice.
WHO IS A FIDUCIARY?
NAMED Anyone specifically named in the plan document as fiduciary (plan sponsor is the fiduciary by default if
FIDUCIARY nobody is specifically named)
DISCRETIONARY
Anyone with authority to make decisions about plan management or assets
ROLE
INVESTMENT
Anyone who provides investment advice for compensation (direct or indirect)
ADVICE
INVESTMENT Registered investment advisors, banks, or insurance companies, that acknowledge in writing that they
MANAGER are plan fiduciaries
Source: Mercer
5 Fiduciary. (n.d.) In Merriam-Webster’s collegiate dictionary. Retrieved from https://www.merriam-webster.com/dictionary/fiduciary.
6
PRI, UNEPFI, UN Global Compact, UN Inquiry (2015). “Fiduciary Duty in the 21st Century”. Retrieved from https://www.unpri.org/download?ac=1378
7 The U.S. Department of Labor’s Employee Benefits Security Administration (2017). “Meeting Your Fiduciary Responsibilities”. Retrieved from https://www.dol.gov/sites/default/
files/ebsa/about-ebsa/our-activities/resource-center/publications/meeting-your-fiduciary-responsibilities.pdf.
8
The Law Commission (2013). “Fiduciary Duties of Investment Intermediaries: Summary of the Consultation Paper”. Retrieved from https://s3-eu-west-2.amazonaws.com/law-
com-prod-storage 11jsxou24uy7q/uploads/2015/03/cp215_fiduciary_duties_summary_web.pdf
Aligning Retirement Assets | Toolkit #1 152 Corporate retirement plans overview
ii. Complying with fiduciary
duty requirements:
Fiduciary duty in the The U.K. Law Commission indicates that the “irreducible core
United Kingdom of fiduciary duty is the duty of loyalty” which the Commission
defines according to four categories:
DUTY OF LOYALTY (U.K.)
No conflict rule: No profit rule: Undivided loyalty rule: Duty of confidentiality:
“A fiduciary must not “A fiduciary must not profit “A fiduciary owes “A fiduciary must not use
place themselves in a from their position at the undivided loyalty to their information obtained in
position where their own expense of the principal.” principal, and therefore confidence from a principal
interest conflicts with the must not place themselves for their own advantage or
principal.” in a position where their for the benefit of another.”
duty towards one principal
conflicts with a duty they
owe to another principal.”
Fiduciary duty in the In contrast to the U.K. concept of the duty of loyalty lying at
European Union the core of fiduciary duty, the European Union’s Institutions for
Occupational Retirement Provision (IORP II) Directive, adopted in
December 2016 indicated that regulated entities must “invest
in accordance with the ‘prudent person’ rule...”
Below is a diagram illustrating three core fiduciary rules
incorporated into the IORP II regulations.
PRUDENT PERSON RULE (E.U.)
“The assets shall be invested in “Within the prudent person rule, “The assets shall be invested in
the best long-term interests of Member States shall allow IORPs such a manner as to ensure the
members and beneficiaries as a to take into account the potential security, quality, liquidity and
whole. In the case of a potential long-term impact of investment profitability of the portfolio
conflict of interest, an IORP, or the decisions on environmental, social, as a whole.”
entity which manages its portfolio, and governance factors.”
shall ensure that the investment
is made in the sole interest of
members and beneficiaries.”
While financial regulatory authorities in other countries may interpret fiduciary duties in different ways, the
general principles outlined above are fairly common internationally.
16 Aligning Retirement Assets | Toolkit #12 Corporate retirement plans overview
Fiduciary duty in the In the United States, private sector retirement plans are governed
United States by the Employee Retirement Income Security Act (ERISA) of 1974.
Under ERISA, fiduciaries’ responsibilities span multiple duties.
FIDUCIARY DUTY (ERISA)
Duty of Loyalty: Duty of prudence: Duty to diversify:
A fiduciary must “run the plan A fiduciary must “discharge his A fiduciary must “diversify plan
solely in the interest of participants duties with respect to a plan investments so as to minimize the
and beneficiaries and for the with the care, skill, prudence and risk of large losses”
exclusive purpose of providing diligence under the circumstances
benefits and paying plan expenses” then prevailing that a prudent man
acting in a like capacity and familiar
with such matters would use in the
conduct of an enterprise of a like
character and with like aims”
Failure to follow these principles of conduct may render a fiduciary personally liable to restore any losses to the
plan, or to restore any profits gained through improper use of plan assets. The imposition of personal liability is
intended to ensure that fiduciaries act prudently and without conflicts in managing retirement plan assets.
Aligning Retirement Assets | Toolkit #1 173
The responsible
retirement
opportunity
Having established the basic elements of how
retirement plans are structured and managed, we
can now turn to examine how sustainable investment
considerations and practices can be integrated into
corporate retirement plans.
18 Aligning
18 Aligning Retirement
Retirement Assets
Assets || Toolkit
Toolkit #1
#13 The responsible retirement opportunity
A. What is a responsible retirement plan?
Compared to a standard i. Overview of responsible operations might be affected by
retirement plan, a plan that could investment approaches:9 climate change impacts (both
be considered “responsible” physically and financially), or the
will take a range of ESG Figure 3 indicates how the impacts that social inequality
three primary responsible can have on a company’s future
considerations into account
investment approaches outlined growth outlook. Sustainability
in selecting investments and
in the following paragraphs can concerns may also extend
constructing a portfolio (for DB be arranged on a spectrum; to top-down, or “macro”
plans) and in offering investment from most to least similar to consideration of how issues
fund options to participants and conventional investing. All four like climate change and social
evaluating investment manager approaches rely on access to inequality might impact financial
performance (for DC plans). ESG-related data to inform the markets at large.
It is important to note, however, investment process and do
that considering ESG factors in not necessitate the sacrifice b. Socially responsible
investing does not necessitate of returns. There is a growing investment (SRI): an
convergence in how investors are investment approach that
sacrificing investment
implementing these approaches emphasizes values alignment,
performance.
as the practices are integrated typically achieved through
into financial practice more avoiding investments in certain
broadly. Working definitions of sectors and/or companies by
each approach follow: negatively screening a portfolio
for investments deemed to be
a. Responsible investing: an unacceptable typically on moral/
approach to investing that ethical grounds, but also in
takes one or all of the following reaction to concerns regarding
investment strategies into the financial stability of sensitive
account (SRI, ESG, or impact). industries, such as tobacco or
Considering sustainability in firearms manufacturers. SRI can
investments typically indicates also utilize positive screening
that an investor takes a longer- methods, where an investor
term view with respect to seeks out companies that are
desired investment outcomes “best in class” on ESG matters
and a broader perspective on for inclusion in an investment
the risks and opportunities portfolio.
facing investments.
A related strategy is for
Typical bottom-up concerns investors to actively engage
related to sustainability could with the companies and
be a company’s impact on the investment managers they are
environment, how a company’s invested with, also known as
active ownership, in order to
drive those firms to act in ways
that are aligned with investors’
views on social responsibility.
9
Responsible Investment, which aligns with the terminology popularized by the UN Principles for Responsible Investment, is often used as a synonym for Sustainable Investment.
These terms go in and out of favor depending on the geographic region or the constituency being addressed. In this paper the terms are used synonymously.
Aligning Retirement Assets | Toolkit #1 193 The responsible retirement opportunity
c. ESG Investment: this performance are examples of an investment is intended
approach prioritizes value ESG data that investors might to have a positive impact
enhancement through the take into account in evaluating on a specific environmental
integration of information a company for investment, and or social issue or theme,
regarding ESG topics into the certain “thematic” funds are while earning competitive
assessment of investment organized around investing in investment returns.10 A related
risks and opportunities, with an reference to such ESG themes. element is measurement and
emphasis on evaluating ESG quantification of the impact that
information that is material d. Impact investment: an investment has on the issue
to a company’s financial this approach places an or theme to be addressed, and
performance. Greenhouse gas explicit emphasis on the disclosure of those figures, in
emissions, labor law violations intention underlying an order to better inform overall
or the alignment of senior investment decision, where impact investment practices.
management compensation
with environmental
Figure 3: A representative taxonomy of responsible investment approaches and methods
RESPONSIBLE INVESTMENT APPROACHES
SRI ESG IMPACT
PRIMARY
OBJECTIVE: Values Alignment Value Enhancement E/S Impact + Return
SCREENING
ESG INTEGRATION
METHODS
THEMATIC INVESTING
ACTIVE OWNERSHIP
Source: Mercer
10
Note, some impact investments are made intentionally at below market financial rates of return. However such investments are typically made by foundations and so are not
considered here. For more information regarding impact investing see: http://www.thegiin.org/
20 Aligning Retirement Assets | Toolkit #13 The responsible retirement opportunity
ii.Overview of Responsible Typically, no sector or d. Active Ownership: Also
Investment Methods investment opportunity is referred to as investment
automatically excluded from a stewardship, active ownership
a. Screening: there are two types portfolio. Some investors utilize is an investing method whereby
of screens employed: ESG indicators purely for risk investors seek to use their
Negative screening: the management purposes, while position as an equity owner - or
exclusion of companies that are for others, these indicators are as a creditor - to influence the
involved in activities or products fundamental to idea generation activity or behavior of investees.
with a perceived negative and portfolio construction as This typically manifests through
impact on society, such as well as for alpha generation. the activities of proxy voting and
armaments manufacturing, Such integration considerations engagement. The aim is usually
tobacco production, gambling, can typically lead investors to bring a corporation in line
alcohol, and animal testing, or to make buy/hold/sell, or with best practice in a particular
companies with poor records overweight/underweight area, and most commonly to
of ESG performance. While decisions. improve standards of corporate
these decisions are most governance, as well as to
often driven by ethical/moral c. Thematic Investing: While not better understand fundamental
considerations, in some cases all themed funds are focused business drivers related to ESG
a stronger financial perspective on sustainability, many do have issues. In combination with
to exclusions is emerging. a clear environmental or social other responsible investment
thematic focus. These funds approaches, active ownership
Positive screening: the inclusion have proliferated in recent should better align the time
of stocks/bonds based on years with the emergence of horizon and interests of the
whether the company has sustainability as a key societal corporation with that of its long
a positive ESG trait, such as and investment trend driving term investors.
an overall high ESG score, long-term growth and returns in
whether the company belongs incumbent and new industries.
to a certain industry sector, Focus funds or activist funds
or displays other favorable can be seen as themed funds
characteristics desirable to the within the governance area.
investor or its beneficiaries. Funds with a social theme can
be found in microfinance, urban
b. ESG Integration: Investors
regeneration, property and
utilizing this method are
social infrastructure projects.
typically traditional fund
Environmental funds tend to
management companies which
focus on renewable energy,
have begun to actively take ESG
energy efficiency or clean
issues and themes into account
technology.
in the fundamental research,
analysis and decision-making
processes.
Aligning Retirement Assets | Toolkit #1 213 The responsible retirement opportunity
B. Context for the implementation of a responsible retirement plan
As noted above, for DB plans, ESG factors in evaluating However, in order to reach
pursuing an ESG integration what investment fund options the point of implementation,
approach might involve to offer participants, and in retirement plan sponsors will first
considering ESG factors in the evaluating investment manager need to understand their specific
process of selecting investments performance. Overall, a variety regulatory context and address
concerns regarding the relevance
and constructing a portfolio. of plan sponsor investment
of ESG to financial performance,
On the other hand, DC plan activities can feasibly consider
both of which will have direct
fiduciaries might consider ESG factors (see Figure 5). bearing on interpretation of their
fiduciary duties.
Figure 4: The relevance of ESG considerations to various plan sponsor investment activities
Proxy
Asset Portfolio Lineup Manager Manager Participant
ACTIVITY voting /
allocation construction11 construction selection monitoring communication
engagement
PLAN TYPE DB DB DC DB/DC DB/DC DB/DC DB/DC
DB plan DB plan DC plan DB/DC plan DB/DC plan Communicating Monitoring
sponsors sponsors might sponsors might sponsors sponsors to participants in investment
might consider their consider the might consider might monitor both DB and DC managers’
consider exposure in interests of the quality managers plans regarding voting and
the impact public equities participants of the ESG for the the impact of their engagement
of systemic say to ESG risk in offering investment implementation investments on activity
risks like characteristics standalone process of their ESG environmental and particularly on
climate similar to ESG-themed adopted by investment social outcomes. controversial
change considering or sustainable potential process and/ ESG issues
EXAMPLES or social exposure investment managers or the ESG (where
OF ESG inequality to other risk options. in selection characteristics voting and
on their factors like decisions, and/ of their engagement
RELEVANCE
overall asset value or growth. or the ESG portfolios. authority is
allocation characteristics characteristics delegated by
strategy. similar to of current/past the sponsor to
considering portfolios. managers).
exposure
to other risk
factors like
value or growth.
11
While asset allocation provides investors with the asset class framework for allocating capital, portfolio construction involves implementing in each asset class. There are many
different ways investors can gain exposure to asset classes today which vary by strategy type (e.g. active vs passive), vehicle (e.g. separately managed accounts (SMAs) vs
mutual funds), etc.
22 Aligning Retirement Assets | Toolkit #13 The responsible retirement opportunity
i. Regulatory landscape:
Across the globe there are South Africa, the United Kingdom developments shifting guidance
two primary legal frameworks and the United States. Civil law for investors. While it is not the
that govern the interpretation countries include Germany, Japan, goal of this document to provide
and application of law in each France and Brazil, among others. legal advice, nor to catalogue all
country: common law and civil Apart from these overarching elements of international financial
law. Common law, which broadly legal frameworks, ESG and regulations, the following is a short
derives from English law traditions, fiduciary duty considerations review of recent developments in
is frequently found in countries have been interpreted and three major markets:
with historical ties to England, codified quite differently in
including Australia, Canada, different countries, with frequent
Common law jurisdictions Civil law jurisdictions
In these countries, laws are generally In civil law countries, laws are generally
uncodified, which means that there codified, meaning that the law is
is no comprehensive compilation of encompassed in legal codes that are
legal statutes and codes. Common law comprehensive and continuously
generally relies on judicial precedent, or updated. Under this system, the role of
decisions that have been made in similar judicial precedent is less significant than
cases, in addition to legislative actions is the role of legislators who draft and
that define statutes.12 interpret the codes.14
Under common law systems, fiduciary Under civil law systems, therefore, the
duties represent the core source limits concept of “fiduciary duty” is encoded
of discretion of investment decision in statutory provisions that regulate
makers, and these duties stand apart the conduct of investment decision
from any regulatory or contractual makers. However, formal recognition of
constraints imposed on investment these duties does not necessarily exist
decision makers. These duties are separately from the relevant statutes.15
articulated in statutes and may be
reinterpreted over time.13 In civil law countries, considering ESG
as a core component of fiduciary duty
ESG and fiduciary duty considerations may require the adoption of supportive
will be subject to interpretation under legal statutes to legally embed ESG into
common law regimes, likely supported by investment practices.
legislative and/or statutory changes.
12
The Common Law and Civil Law Traditions. (n.d.). Retrieved from https://www.law.berkeley.edu/library/robbins/CommonLawCivilLawTraditions.html
13
PRI, UNEPFI, UN Global Compact, UN Inquiry (2015). “Fiduciary Duty in the 21st Century”. Retrieved from https://www.unpri.org/download?ac=1378.
14
The Common Law and Civil Law Traditions. (n.d.). Retrieved from https://www.law.berkeley.edu/library/robbins/CommonLawCivilLawTraditions.html
15
PRI, UNEPFI, UN Global Compact, UN Inquiry (2015). “Fiduciary Duty in the 21st Century”. Retrieved from https://www.unpri.org/download?ac=1378.
Aligning Retirement Assets | Toolkit #1 233 The responsible retirement opportunity
European Union: In • Hold an effective, transparent • Produce and review a
December 2016 the European system of governance that Statement of Investment
Union officially adopted includes consideration of ESG Policy Principles at least every
a revised Institutions for factors relating to investment three years, or immediately
Occupational Retirement decisions. This system should following significant changes
be proportionate to the nature, to investment policy. This must
Provision (IORP II) Directive,16
scale and complexity of the IORP be made publicly available and
which required that EU
(Article 21). explain whether and how the
Member States integrate investment policy considers
the directive into national • Establish a risk management ESG factors (Article 30).
law within 24 months. function and procedures to
The Directive requires identify, monitor, manage • Inform prospective scheme
occupational retirement plan and report risks. ESG risks members whether and how
providers with more than associated with the investment the investment approach
portfolio and its management takes ESG factors into
100 members to evaluate
are included in the list of risks account (Article 41).
ESG risks and disclose
that the risk management
information to members. system must cover. This system Such clear and multifaceted
As described by the UN should be proportionate to the requirements, which respond
Principles for Responsible nature, scale and complexity of directly to questions of
Investment, the Articles of the the IORP (Article 25). fiduciary duty and ESG, will
Directive require occupational provide some clarity to EU
retirement plans to:17 • Carry out and document their retirement plan fiduciaries
own risk assessment at least regarding their duties with
• Invest in accordance with every three years, or without respect to ESG integration.
the Prudent Person Principle. delay following a significant
The Directive clarifies that change in the risk profile.
this means acting in the best This risk assessment should
long-term interests of their include, where ESG factors are
members as a whole, and that considered, an assessment of
the Prudent Person Principle new or emerging risks including
does not preclude funds climate change, resource use,
from considering the impact social risks and stranded assets
of their investments on ESG (Article 28).
factors (Article 19).
16
The full text of the Directive is available here: http://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:32016L2341
17
The following bullet points are quoted from United Nations Principles for Responsible Investment (2016). “Policy Briefing: Institutions for Occupational Retirement Provision
(IORP) Directive: ESG Clauses.” Retrieved from https://www.unpri.org/download?ac=1430.
24 Aligning Retirement Assets | Toolkit #13 The responsible retirement opportunity
United Kingdom: In September United States: In 2018 the U.S. Department
2018, the U.K. Department of Work and of Labor (DOL) issued Field Assistance
Pensions issued a governmental response Bulletin (FAB) 2018-01,19 which addresses
to a consultation on “Clarifying and the extent to which fiduciaries governing
Strengthening Trustees’ Investment ERISA-compliant retirement plans can take
Duties” that proposes out new regulations ESG factors into account in investing plan
regarding the consideration of ESG factors assets. FAB 2018-01 cautions fiduciaries
by fiduciaries. The new regulations clarify against too readily treating ESG factors as
that it is the duty of pension trustees to economically relevant, as well as sacrificing
consider financially material risks and return or increasing risks “to promote
opportunities, including ESG topics like collateral social policy goals.” While the
climate change, in addition to traditional DOL indicates skepticism regarding ESG
financial metrics. A core element of the matters, the Government Accountability
proposed new regulations is that, as of Office (GAO), in a report released shortly
October 1, 2019, certain retirement plans after FAB 2018-01, highlighted the fact that
will be required to update their “Statement DOL’s FAB may lead to confusion among
of Investment Principles” (also known as ERISA fiduciaries regarding financially
Investment Policy Statements in other material ESG factors.20 GAO called for further
markets) to reflect both how they take ESG clarification from DOL regarding whether
issues into account, as well as stewardship and how fiduciaries can consider financially
polices defining how these plans engage material ESG factors in investment decisions,
with investee firms and vote their proxies.18 which DOL has not yet committed to issue
Such new regulatory actions appear set to as of this writing. Ultimately, however, the
dramatically shift the landscape of how U.K. U.S. regulatory landscape for fiduciary
pensions account for ESG considerations in consideration of ESG issues stands in
their investment decision making. contrast to other major markets for the lack
of clarity from regulators.
18
Department of Work and Pensions, United Kingdom (2018). “Clarifying and strengthening trustees’ investment duties: Government response.” Retrieved from https://assets.
publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/739331/response-clarifying-and-strengthening-trustees-investment-duties.pdf.
19
U.S. Department of Labor (2018). Field Assistance Bulletin 2018-01. Retrieved from https://www.dol.gov/sites/default/files/ebsa/employers-and-advisers/guidance/field-assis-
tance-bulletins/2018-01.pdf.
20
U.S. Government Accountability Office (2018). “Retirement Plan Investing: Clearer Information on Consideration of Environmental, Social, and Governance Factors Would Be
Helpful.” Retrieved from https://www.gao.gov/assets/700/691930.pdf
Aligning Retirement Assets | Toolkit #1 253 The responsible retirement opportunity
ii. Data Issues:
Responsible investors argue that For example, Mercer’s climate By some accounts, over
the past is no longer prologue to change model, released in 150 providers of ESG data on
the future, that we are entering 2015, evaluated the expected companies are in the market,
new economic regimes driven by performance of various asset offering more than 650
changes in the environment and classes across a number of individual data products.22
society which cannot effectively different potential climate The proliferation of ESG data
be analyzed using backward- scenarios, providing quantitative has been aided by increasing
looking quantitative approaches, guidance to investors seeking transparency of sustainability
as are often emphasized in to build more climate-resilient activities23 and a simultaneous
investment decision making. For portfolios.21 lack of ESG data standards24
example, it is difficult to back test creating a need for third-party
for the impact of climate change While not all systemic research and interpretation of
on investments since climate environmental and social disclosed (and undisclosed)
change to the extent expected challenges or “megatrends” information.
has not happened previously in can be addressed in the same
human history. way, investors could benefit Such data diversity impedes
from considering risks and regular quantitative back
One approach that investors opportunities in a similarly testing methods used often
and others have taken to forward-looking, qualitative to analyze financial data which
mitigate such data challenges manner as part of due diligence is more reliably reported and
is to develop scenario analyses processes. audited. Also, many ESG data
that attempt to analyze providers necessarily utilize
possible future financial and To support the assessment of subjective methodologies to
economic outcomes according idiosyncratic ESG issues which fill gaps in reported data or
to different levels of global differ at the company level, a to make assumptions about
average temperature increase. host of ESG data providers have company disclosures and these
entered the market offering methodologies sometimes
competing and complimentary change over time. Moreover, even
data services to investors. the most robust ESG databases
only extend one or two decades
back in time. All of this can make
finding a clean, clear and long-
term dataset to support statistical
analysis challenging.
21
Mercer. (n.d.). Investing in a Time of Climate Change. Retrieved from https://www.mercer.com/our-thinking/wealth/investing-in-a-time-of-climate-change.html
22
Global Initiative of Sustainability Ratings (GISR) – Data Hub, accessed August 2017
23
Governance & Accountability Institute. (n.d.). FLASH REPORT: 85% Of S&P 500 Index® Companies Publish Sustainability Reports In 2017. Retrieved from https://www.business-
wire.com/news/home/20180320006125/en/FLASH-REPORT-85-SP-500-Index%C2%AE-Companies
24
While several organizations including most notably the Sustainability Accounting Standards Board (SASB) and the Taskforce on Climate-Related Financial Disclosures (TCFD), are
working to develop disclosure/reporting standards for ESG data, no notable standards are imposed by regulators today.
26 Aligning Retirement Assets | Toolkit #13 The responsible retirement opportunity
iii. Empirical Evidence:
A frequent question investors In examining ESG integration Active ownership, which entails
ask is whether considering investment approaches, the voting proxies and engaging
ESG factors in decision making empirical record shows generally with company management
necessarily involves sacrificing positive contributions to portfolio teams around controversial
some measure of investment performance. In 2018 the U.S. ESG management practices, is
performance. To the extent Government Accountability Office another investment technique
that applying an SRI-focused (GAO) conducted a detailed study often employed by responsible
approach of screening out of ESG investment trends in investors. While less well studied
sensitive investments from a retirement plans and conducted than ESG integration, active
portfolio reduces the investable its own meta-study of ESG owners have demonstrated
universe available to an investor, investment research articles. In a positive impact on return
then modern portfolio theory looking at studies conducted outcomes. Analyzing a database
(MPT) which is underpinned by between 2012 and 2017, the of environmental and social
the Efficient Market Hypothesis GAO found that 88% of scenarios engagements with US public
(EMH) dictates that long-term evaluated in those studies found companies over 1999–2009,
risk-adjusted performance a neutral or positive relationship a group of researchers found
would be sacrificed compared between the consideration of engaged companies produced
to an unconstrained portfolio.25 ESG data and financial returns cumulative abnormal returns
There are certainly examples of when compared to otherwise of +1.8%. After successful
instances where organizations comparable investments.29 engagements, companies
have divested from a certain experienced improvements
security or class there of and The GAO also notes that a in operating performance
experienced financial losses as study commissioned in 2017 profitability, efficiency and
a result.26 by the U.S. Department of governance.31
Labor reported that a review of
However, in examining research academic literature published While misperceptions regarding
on SRI investment performance, between 2006-2016 found that ESG investment approaches are
theory has not always played incorporating ESG factors in unfortunately persistent among
out in practice. In fact, negatively investments typically produced investors and the public, an
screened portfolios often perform performance that is comparable increasing amount of evidence32
in line with and sometimes better to or better than investments that indicates that ESG integration
than unscreened portfolios27 did not incorporate ESG.30 tends to produce positive
though much depends on the performance outcomes far more
industry screened, the timeframe often than not.
of assessment and the metrics
used to evaluate performance.28
25
For a high-level overview of MPT refer to: https://www.investopedia.com/terms/m/modernportfoliotheory.asp. For the purposes of this document, it is important to understand
that MPT presumes market efficiency and is by far the most dominant investment theory, underpinning most quantitative investment models in use today.
26
The Wall Street Journal (2016). Soaring Tobacco Stocks Prompt CalPERS to Reconsider Investment Strategy. Retrieved from https://www.wsj.com/articles/tobac-
co-gains-prompts-fund-to-reconsider-investment-strategy-1461914447
27
Mercer (2017). Preparing Portfolios for Transformation. Page 32-33. Retrieved from https://www.mercer.com/our-thinking/assessing-the-prospective-investment-im-
pacts-of-a-low-carbon-economic-transition.html
28
Jeremy Grantham (2018). The mythical peril of divesting from fossil fuels. Retrieved from http://www.lse.ac.uk/GranthamInstitute/news/the-mythical-peril-of-divesting-from-fos-
sil-fuels/
29
U.S. Government Accountability Office (2018). Retirement Plan Investing: Clearer Information on Consideration of Environmental, Social, and Governance Factors Would Be
Helpful. GAO-18-398. Pages 7-8.
30
Ogechukwu Ezeokoli,.et al., Summit Consulting, LLC (2017). Environmental, Social, and Governance (ESG) Investment Tools: A Review of the Current Field.
31
Dimson, Karakas & Li; Active Ownership (2013)
32
For perhaps the definitive meta-analysis of ESG studies, see: Gunnar Friede, Timo Busch, and Alexander Bassen (2015). “ESG and Financial Performance: Aggregated Evidence
from More Than 2000 Empirical Studies,” Journal of Sustainable Finance & Investment, vol. 5 no. 4.
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