Getting Started with ESG Fund Evaluation – WealthManagement.com

Getting Started with ESG Fund Evaluation WealthManagement.comGetting Started with ESG Fund Evaluation WealthManagement.comGetting Started with ESG Fund Evaluation WealthManagement.com

An email was sent by the chair of an investment committee from one of your plans asking for your opinion on adding an ESG (environmental social and governance) fund into your 401(k). Employees have been reaching out to the HR department to express their interest in a responsible investing option. This option is currently not available to the plan. Could you prepare a presentation to the next investment committee meeting containing your thoughts about possible fund additions. These approaches, whether they’re called ESG, responsible investment, or sustainable investing, continue to be popular. If your participants and sponsors haven’t asked about ESG yet, they can expect to soon. According to US SIF: Forum for Sustainable and Responsible Investment, “The United States saw an increase of 42 percent in assets under professional management that took ESG factors into consideration between 2018 and 2020, from $12.0 trillion and $17.1 trillion. This represents one-third of all dollars under professional management. Although most of this activity has been generated by institutional asset owners, studies by the Morgan Stanley Institute for Sustainable Investing (NSI) and Natixis Global Asset Management (Natixis) show that there is increasing demand from individual investors. Related: ESG in Retirement Plans: What’s the Current Situation? Even if a plan expresses interest it is likely to be cautious. Clear regulations govern equity and fixed income funds in a plan lineup. While the Biden administration is perceived to favor ESG-focused investments over others, regulators have had varying attitudes over the years. Some plan sponsors are reluctant to include ESG options in target funds before the Department of Labor’s position has been fully clarified, says Tim Kohn (head of retirement at Dimensional Fund Advisors) and he expects clarifications to arrive soon. Evaluating ESG-Focused investments Related: How to Separate Real ESG Fonds From the Not So RealMost plan consultants will have a documented process for reviewing funds that are under consideration or already in a plan. This process will use data from multiple sources, and it’s possible that a third-party analytical service’s fund rating will be a factor. Evaluating ESG performance can be complicated and require different metrics and data. The resulting ESG ratings can be disputed. According to a May 2021 DFA whitepaper, ESG Data, Ratings and Investor Objectives, ESG rating providers “frequently disagree about company ratings.” A company may be rated as “best-in-class” by one provider, but as average by another provider. The paper warns against using ESG ratings. “Given ESG ratings’ subjectivity, we believe they should not be regarded as objective ratings but as opinions. This is similar to the buy/hold/sell opinions issued by sell-side analysts over the past decades. Investors should be aware that ESG ratings provided by one provider may have drastically different ratings and opinions. The August 2021 DFA whitepaper “Beyond Label, ESG Funds may Miss Their Mark”, also cautions investors about reviewing ESG funds. The paper’s main takeaways are: “Components and methods of incorporating ESG into an investment strategy can result in a wide range investment outcomes. ESG strategies have a wide range of characteristics that may lead to expected returns that are different from the market. ESG strategies have had a wide range of greenhouse gas emissions. This highlights the importance to look beyond ESG labels when determining whether an ESG investment is compatible with one’s goals. Staying on Track Will Collins Dean is a senior portfolio manager at DFA and has many suggestions for sponsors and consultants who are beginning to evaluate ESG opportunities. An alternative to a “kitchen sink” approach is to choose a clearly stated ESG goal. Focusing on corporate governance or greenhouse emissions, instead of a broad approach, can increase research efficiency and the resulting analysis. Collins Dean explains that there are often many offerings that try to address a large number ESG variables. This can lead to two states. You could end up having a concentrated offering, or you could have a more diverse offering. However, it doesn’t move the needle in any particular direction because of the offsetting effects from the large number variables. Collins Dean says it’s important to keep in mind the role of ESG-investments as a component of a portfolio. He says that just because you are evaluating an ESG option doesn’t mean you should sacrifice the core tenants that we believe are essential to a reliable investment strategy: diversification and cost effectiveness, systematic approach to pursuing securities at higher expected returns, and a systematic approach to doing so. These are as important in the ESG area as they are outside.

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