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What Might a Responsible Corporate Retirement Plan Look Like?

Director, North America, of the World Business Council for Sustainable Development Principal and Head of Responsible Investment for Mercer

The trend toward considering environmental, social and governance criteria (ESG) in investment decision-making is growing rapidly year-over-year among investors of all types, from institutions to individuals. However, there is one particular pool of capital that, to date, has been slow to integrate ESG factors into investment decisions: corporate retirement plans.

This lack of attention to ESG factors—which may be material indicators of risk and opportunity—extends across both defined contribution plans, such as 401(k) accounts in the United States, as well as defined benefit plans.

The Benefits of an ESG Retirement Plan

Many surveys have shown that younger employees in particular may save more for their retirement when offered investment options that reflect their values, and a growing body of literature points to the performance benefit of ESG integration.

Motivated in part by this promising research, the World Business Council for Sustainable Development and Mercer have developed a tool kit to help companies explore how to support company pension plans to consider responsible investment principles and practices.

Compared to a standard retirement plan, a plan that could be considered “responsible” would take a range of ESG considerations into account when selecting investments. Here are a number of the more commonly used methods to implement a responsible investment portfolio:

  • Screening typically involves the exclusion of companies or sectors that are perceived as having a negative impact on society (negative screening), or the explicit inclusion of companies or sectors perceived to have a positive impact on society (positive screening).
  • ESG integration seeks to take ESG issues actively into account as part of the fundamental research and analysis of investment options; generally, no sector or company is automatically excluded under this method.
  • Thematic investing methods orient investment decisions and portfolio construction activities around specific ESG themes, such as financial inclusion or renewable energy, with the goal of providing an investor explicit and concentrated exposure to the thematic area in question.
  • Active ownership methods are applicable across all three responsible investment methods described above. They involve investors using their status as owners of a company (in equity investments) or as creditors to bring a company in line with best practices in a particular area or to enhance corporate governance standards. A common approach is for equity investors to vote their proxies according to ESG considerations and engage with companies on specific ESG topics. The overarching goal is typically to better align the value creation and time horizon of the company with the interests of its long-term investors.

Offering responsible retirement plan options to today’s values-driven recruits could also help to enhance a company’s attractiveness to talent.

What Else Do I Need To Know?

There are a number of key issues that retirement plan sponsors must consider if they wish to integrate responsible investment approaches into their retirement plans:

  • Regulations: In most regions of the world, there is generally an increasing understanding and acceptance of the materiality of ESG considerations for long-term investment performance among financial regulators.
  • Data challenges: A core tenet of responsible investment is that the past is no longer prologue when it comes to assessing risks and opportunities. While current/historical ESG data standards and disclosure practices are improving, investors and others have developed scenario analyses to mitigate such data challenges that attempt to analyze possible future financial and economic outcomes according to different levels of global average temperature increase, for instance, although this approach is still not in widespread use.
  • Responsible investment performance: A common perception among investors is that considering ESG factors in decision-making necessarily involves sacrificing some measure of investment performance in the pursuit of values alignment. Contradicting this widespread belief are a raft of academic and industry studies that show ESG integration most often produces positive, or at worst, neutral outcomes.
  • Fiduciary duty considerations: Fiduciary duty must be considered in any course of action a retirement plan might take, or else it may run the risk of being exposed to regulatory and/or legal action. A fairly common fiduciary duty element across major jurisdictions is the duty of loyalty, which requires that the retirement plan be run solely in the best interests of the beneficiaries and participants in the plan, with no conflicts of interest. A secondary, but nonetheless essential, fiduciary duty requirement is the prudent person rule, which requires retirement-plan fiduciaries to invest on behalf of beneficiaries as a similarly situated prudent person would. Responsible investment approaches, thoughtfully applied, can be fully in line with these requirements.

ESG Can Drive Up Pension Enrollment

Integrating responsible investment approaches into corporate retirement plans represents an exciting opportunity to potentially improve plan participant outcomes by enhancing investment performance and/or increasing participant savings rates or engagement.

Offering responsible retirement plan options to today’s values-driven recruits could also help to enhance a company’s attractiveness to talent by highlighting the alignment of corporate responsibility across the organization.

Chris Walker

Director, North America, of the World Business Council for Sustainable Development

Chris Walker is North America’s director of the World Business Council for Sustainable Development.

Alex Bernhardt

Principal and Head of Responsible Investment for Mercer

Alex Bernhardt, Principal and Head of Responsible Investment (RI) for Mercer in the U.S., is a noted expert in catastrophe, weather and financial risk management. In his role as U.S. RI leader Alex is driving innovation in environmental and social risk assessment for investors of all types and sizes with a focus on climate change. Prior to joining Mercer, Alex was a senior vice president at Guy Carpenter, another Marsh & McLennan Companies operating company, where he founded and ran the firm’s GC Micro Risk Solutions division.

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