Despite Regulatory Challenges, Defined Contribution Asset Managers Continue to Pursue ESG-Focused Distribution Initiatives

October 1, 2020 — Boston

DC managers plan to increase marketing and distribution efforts associated with their ESG investment products—education around terminology and ESG investing methods could help to promote future adoption by plan sponsors

Despite the perceived barriers to adoption created by recently proposed regulation, most defined contribution investment-only (DCIO) asset managers expect to increase their defined contribution (DC)-focused environmental, social, and governance (ESG) marketing and distribution efforts during the next 12 months, according to Cerulli’s latest report: U.S. Defined Contribution Distribution 2020: Adapting to Changes in the Regulatory Environment.

In June 2020, the Department of Labor (DOL) proposed new regulations requiring ERISA fiduciaries to complete more stringent evaluations of ESG investments and prohibiting the use of ESG-themed funds as a plan’s qualified default investment alternative (QDIA), or a component of a plan’s QDIA. Industry stakeholders suggest the DOL’s proposal will place undue barriers to adoption of ESG products—nearly half (48%) of DCIO asset managers surveyed by Cerulli consider the DOL’s proposal one of the most significant barriers to adoption of ESG products in DC plans.

The regulation is not slowing down marketing and distribution efforts promoting DC-focused ESG products. According to the research, 56% of DCIO asset managers expect to increase these efforts during the next 12 months. “For now, implementing ESG-themed products within a plan’s QDIA is not a viable option from a fiduciary standpoint. However, DC asset managers relate that some of their plan sponsor clients continue to express interest in ESG investments,” states Shawn O’Brien, senior analyst at Cerulli.

Furthermore, many asset managers tout performance-related benefits to incorporating ESG criteria into their investment analysis, even within non-ESG-branded funds. “Many asset managers stand behind the financial merits of ESG. Some asset managers tell us they employ ESG screening processes or incorporate ESG factors into their investment analysis across all of their funds.” remarks O’Brien. Three-quarters (75%) of asset managers cite mitigating risk as a top reason for incorporating ESG criteria into their investment analysis and more than two-thirds (68%) indicate incorporating ESG criteria leads to improved alpha opportunities.

On top of these regulatory headwinds, retirement plan providers suggest confusion related to ESG investing has also contributed to a lack of adoption by DC plans. In the absence of universally accepted definitions and terminology, providers should consider taking a step back to address the fundamentals of ESG investing in order to facilitate more nuanced discussions with their DC clients. “There seems to be a lingering confusion among plan sponsors and participants about how ESG investing works. Managers should seek to educate DC plan sponsors and intermediaries on the various methods of ESG investing and illustrate how their firm’s product fits within the broader ESG landscape,” says O’Brien. “Moreover, helping plan sponsors articulate and document investment decisions related to ESG products—and ensuring those decisions are consistent with the plan’s IPS—will be particularly important given the current regulatory environment and the litigious nature of the DC market,” he concludes.

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