401(k) Plans Need a Plan When Incorporating ESG Investing

The Defined Contribution Institutional Investment Association (DCIIA) has published a paper that offers “tactical steps” it says are consistent with the obligations of fiduciaries incorporating sustainable investing in their plans.

According to the paper, with proper process and documentation, plan sponsors can integrate environmental, social, and governance (ESG) investing into a defined contribution (DC) plan.

“The regulatory approach toward sustainable investing may shift in the future,” the authors wrote. “However, if plan sponsors continue to demonstrably put plan participants’ economic benefits first, plans can be compliant even with current more stringent regulations.”

The paper suggested places sponsors can start by assessing the current platform’s sustainability attributes, integrating sustainability questions into manager requests for proposals (RFPs) or due diligence, and formulating a committee philosophy on sustainable investing.

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“With thoughtful consideration and clear, consistent documentation, plan sponsors may articulate how access to sustainable investing strategies fit in plan design and use this process as a means for participant education and engagement,” said the paper.

DCIIA suggests DC plan sponsors conduct a series of checks and balances, create a decisionmaking process, and provide thorough documentation in order to meet their fiduciary responsibilities. “Clear documentation outlining consistency in due diligence and execution of duty of care can, in turn, help to demonstrate consistency in process, philosophy and execution, and help address concerns about meeting fiduciary duties,” said the paper.

Key recommendations from the paper include:

Define “sustainability” and clarify ESG investment beliefs in plan documents, such as a statement of investment beliefs or an investment policy statement (IPS). “Portfolios are considered sustainable when decisionmakers weigh the impact of ESG factors alongside other traditional financial metrics in portfolio construction and investment management processes,” DCIIA said;

Study key considerations and differences among three implementation options for DC plans to see which path is best for the plan: material ESG factor integration across all investments; selective sustainable investing funds in the plan lineup; or self-directed brokerage windows;

Measure and monitor sustainable investments in a manner consistent with the assessment of other investment options. Sustainable investing funds in alignment with financial benefits can be more deeply reviewed for intentionality and for the ESG attributes of the underlying holdings;

Consult with legal counsel and investment consultants when assessing if, when, and how to implement sustainable investing; and

Maintain clear documentation throughout the process to establish procedural prudence.

“Through research, deliberation, documentation, and attention to the duties of loyalty and prudence, it is possible to successfully incorporate sustainable investing in today’s DC plans,” said the paper.