Based on the history of the DOL’s views on ESG issues in the past, one could argue that the DOL is seesawing back and forth on how fiduciaries should act when considering ESG investments. Most recently, Interpretive Bulletin 2015-01 sought to be more welcoming than prior guidance on ESG investing. IB 2015-01 recognizes ESG as a reasonable investment strategy:
“Environmental, social and governance issues may have a direct relationship to the economic value of the plan’s investment. In these instances, such issues are not merely collateral considerations or tie-breakers, but proper components of the fiduciary’s primary analysis of the economic merits of competing investment choices.”
IB 2015-01 goes on to highlight that fiduciaries should use their normal procedures for evaluation of ESG investments.
A Closer Look at FAB
This FAB represents the new administration’s opinion on this subject. As with previous guidance, it starts with the North Star of fiduciary standards, namely that “fiduciaries may not sacrifice investment returns or assume greater investment risks as a means of promoting collateral social policy goals”. It then reiterates the position of IB 2015-01:
“If a fiduciary determines that an investment is appropriate based solely on economic considerations, including those that may derive from environmental, social and governance [ESG] factors, the fiduciary may make the investment without regard to any collateral benefits the investment may also promote."
The FAB goes on to clarify that these “collateral issues are themselves appropriate economic considerations, and thus should be considered by a prudent fiduciary… In other words, in these instances, the factors are more than mere tie-breakers”. However, it cautions fiduciaries not to put the cart before the horse: specifically, simply because an investment strategy uses ESG factors does not make it prudent from an ERISA fiduciary standard (please note that “ineluctably” means “inescapably”):
“It does not ineluctably follow from the fact that an investment promotes ESG factors… that the investment is a prudent choice…”
The FAB then addresses the issue of investment policy statements, looking to clarify issues brought up in past investment bulletins. Again, the FAB reiterates that investment policy statements do not need to contain guidelines on ESG investments, but that if an investment policy does contain ESG guidelines, it may not be prudent for plan fiduciaries, including ERISA Section 3(38) investment managers, to always follow them. Specifically, the FAB states that “if it is imprudent to comply with the investment policy statement in a particular instance, the manager must disregard it”. It’s unclear why the DOL provided such a strong statement in this FAB. Perhaps they were worried that a plan sponsor – perhaps a mission-oriented non-profit – could adopt an investment policy statement saying something like “we will follow ERISA fiduciary standards as well as the ideals outlined in the mission statement of our organization”. This type of investment policy statement would seem to go too far – the plan fiduciaries have overreached and if they hired a 3(38) investment manager, then this manager would not be able to fulfill his/her duties to the participants.
Impact on 401(k) Plans
Finally, the FAB specifically addresses 401(k) plans, drawing a clear distinction between the fiduciary decisions regarding selection of a qualified default investment alternative (“QDIA”) and simply adding another investment alternative to the plan lineup. In short, the DOL feels comfortable with adding a “prudently selected, well managed and properly diversified ESG-themed investment” since it does not require “the plan to forego adding other non-ESG-themed investment options”. However, the DOL emphasizes that QDIA selection is significantly different – and rightly so – saying “Nothing in the QDIA regulations suggests that fiduciaries should choose QDIAs based on collateral public policy goals”. The FAB reiterates that plan fiduciaries looking to select an ESG-themed target date fund as a QDIA must do so without regard to any other collateral benefits. The ESG-themed target date fund must stand on its own merits in a straight-up comparison with any other QDIA alternatives. The DOL is clearly seeing the choice of QDIA as a critical fiduciary duty that deserves special attention. Using this same logic plan fiduciaries would also be wise to review their QDIA selection process, especially if using the target date funds of the plan administrator. Any “collateral benefits” from use of proprietary target date series may not be considered prudent based on the opinion contained within this FAB.
Where Does This Leave ERISA Plan Fiduciaries – Especially 401(k) Plan Sponsors?
Clearly, ESG investing continues to be a concern for the DOL. The most recent bulletin seeks to provide more clarity around the DOL’s thinking about how plan fiduciaries can implement ESG investments within the confines of ERISA qualified plans. The primary investment guideline for ERISA fiduciaries continues to be to select prudent, well diversified funds with reasonable risk/reward tradeoffs. ESG funds should be evaluated alongside other competing fund alternatives – ESG or not – and should be subject to the fiduciary’s normal due diligence process. In particular, this bulletin highlights the extra special concern for QDIA selection. So, by adopting, following and documenting a prudent investment selection process, fiduciaries should feel confident when evaluating whether to add ESG funds to their plan’s lineups.
About the Author:
Dan Cassidy, FSA, CFA®
Dan is a senior advisor at the River & Mercantile Group. In over 25 years working with plan sponsors, Dan has specialized in cutting-edge approaches to risk management. Integrating investment, actuarial and fiduciary advice, Dan works with plan sponsors to maximize the effectiveness of their retirement programs.
This material is intended for informational purposes only, does not constitute investment advice and should not be construed as a recommendation for investment action. The information provided does not take into account the investment objectives, risk tolerance, restrictions, liquidity needs or other characteristics of any one particular investor.