neuberger berman environmental, social and governance ... index dow jones sustainability index -...

A GUIDE FOR PLAN FIDUCIARIES

Environmental, Social and Governance Investing

NEUBERGER BERMAN

A growing number of investors are not only looking for attractive performance from their

investments, but also want their investments to incorporate sustainability criteria. Driven

by enhanced participant interest and significant product developments, plan fiduciaries are

increasingly interested in incorporating environmental, social and governance (ESG) considerations

within defined contribution plans.

To help plan sponsors navigate the world of ESG investing, in this guide, we:

• Define ESG and present the key growth drivers for ESG investments in retirement plans

• Explain key considerations for fiduciaries evaluating ESG investments

• Outline approaches for incorporating ESG investments into retirement plans

ESG INVESTING: A GUIDE FOR PLAN FIDUCIARIES 1

ENVIRONMENTAL

How a company performs as a steward

of the natural environment.

Considerations: Carbon footprint,

pollution and use of toxic chemicals,

waste disposal, preservation of natural

resources.

Potential financial impact: Long-

term stability, lower waste, lower costs,

more efficiency, reduced uncertainty,

ability to adapt to increasingly stringent

environmental regulations or restrictions.

Provide economic solutions to

environmental problems.

SOCIAL

How a company manages its business

relationships with its employees, client

base and surrounding communities.

Considerations: Fair employment

policies, labor relations, supply chain

issues, ethical issues, community

involvement, reliable health and safety

standards, infrastructure and education.

Potential financial impact:

Retain and attract human capital,

increase workplace productivity,

improve security and reliability of supply

chain, potentially avoid interruption,

reputation-damaging controversies and

class-action lawsuits.

GOVERNANCE

How a company is structured, including

business practices and level of

transparency.

Considerations: Management and

board structure, executive compensation

metrics, accounting policies, diversity,

independence, compensation, political

contributions and lobbying.

Potential financial impact: Make

choices that are in the best interest

of shareholders, make good on future

liabilities, implement reasonable

executive pay, prevent corruption.

ESG DEFINEDAlthough it can go by many names and be implemented in a number of ways, ESG investing, in essence, is the practice of incorporating

environmental, social and governance considerations in the investment process.

2 ESG INVESTING: A GUIDE FOR PLAN FIDUCIARIES

We believe that ESG considerations can have a material impact on a company’s financial performance, access to cash flow, growth potential

and risk mitigation. Specifically, responsible and sustainable business practices may help companies plan more effectively and seamlessly adjust

to changing regulations and increasingly scarce resources, avoid potential controversies and deliver on long-term liabilities. A company that can

attract, retain and engage employees—or one that manages resources efficiently and designs products and services to address environmental

challenges—may offer competitive advantages, with the potential to achieve better long-term financial performance than a similar company

that measures poorly on such sustainability issues.

Integrating ESG research into the investment process alongside traditional financial analysis can provide insight into the quality of a company’s

management, culture, risk profile and other characteristics. This practice allows active portfolio managers to identify companies that aim to

effectively plan for the future by capitalizing on the benefits of astute governance, environmental responsibility and broader stakeholder

management.

ESG investing is not an asset class in itself, but an investment approach that can be employed across asset classes and investment

disciplines. ESG considerations have been widely adopted within public domestic equity markets, and have also been successfully

implemented within fixed income, alternatives and private markets. There are also various approaches for integrating ESG considerations in

the investment process, as described below.

ESG INVESTMENT STRATEGIES

NEGATIVE/EXCLUSIONARY: The exclusion of certain sectors or companies involved in activities or industries deemed unacceptable or controversial.

POSITIVE/BEST-IN-CLASS: Investment in sectors, companies or projects selected for positive ESG performance relative to industry peers. This includes avoiding companies that do not meet certain ESG performance thresholds.

ESG INTEGRATION: The systematic and explicit inclusion by investment managers of ESG risks and opportunities into financial analysis.

IMPACT INVESTING: Investment in companies, organizations and funds, often in private markets, with the intention to generate social and environmental impact alongside a financial return.

SUSTAINABILITY THEMED INVESTING:

Thematic portfolio construction around specific ESG areas, such as gender-lens, clean technology, sustainable food and agriculture, renewable energy, or place-based investing.

Source: Forum for Sustainable and Responsible Investment (US SIF Foundation) Report on Sustainable, Responsible and Impact Investing Trends 2018.


POTENTIAL BENEFITS

We believe ESG investing within retirement plans could have a number of

potential benefits for both plan sponsors and plan participants:

• May provide attractive long-term risk-adjusted returns for plan

participants. The key goal for retirement plan fiduciaries is to be responsible

stewards of capital and to help participants accrue assets for their retirement.

• Enhance corporate reputation and attract talent with retirement

benefits inclusive of ESG offerings demonstrating commitment to all aspects

of sustainability. For example, employees who value their organization’s

diversity profile can now access investments with similar attributes.

• Increase participant engagement in the plan, as participants may

be more likely to contribute to investments that meet both financial and

sustainability needs.

• Align an organization’s mission with plan investments. Many

corporations have built both a brand and reputation on thoughtful ESG

considerations. Having plan investment options consistent with this is an

extension of their efforts. For example, a corporation with a sustainability

focus or mission may want its retirement plan options to align with its

sustainability goals and as a result broaden its impact.

EXPONENTIAL GROWTH WITHIN ESG INVESTING

Investments in strategies that incorporate ESG considerations have experienced significant growth in recent years. This growth is indicative of broad investor interest, including public retirement plans, private retirement plans, religious organizations, education institutions, health care institutions, and small and medium-sized business owners. In fact, 40% of investors surveyed today already own or are interested in ESG investments.1

ESG INVESTING CONTINUES TO GAIN TRACTION

AUM

(Tril

lions

)

3.1 3.8

6.98.7

02468

1012

‘18‘16‘14‘12‘10

12

Source: Forum for Sustainable and Responsible Investment (US SIF Foundation) Report on Sustainable, Responsible and Impact Investing Trends 2018.

U.S. AUM invested in sustainable strategies:

2012 $1 out of every $9

2018 $1 out of every $4


KEY CONSIDERATIONS FOR FIDUCIARIES

$35,724$29,846$28,342

Dow Jones Sustainability Index – U.S. S&P 500

U.S. Active Large Cap – ESG

$0

$10,000

$20,000

$30,000

$40,000

$50,000

‘18‘16‘14‘12‘10‘08‘06‘04‘02‘00

PERFORMANCE

As fiduciaries, a key focus around ESG investments has been the question of competitive

long-term performance. Evidence is growing that investment strategies that integrate ESG

considerations into the fundamental investment process can positively impact a company’s

profitability. In other words, investing in ESG strategies can provide competitive long-term

risk-adjusted returns. As with other strategies, it is important that fiduciaries consider the

length of track record and the critical mass of assets when evaluating ESG investments.

December 31, 2018

U.S. Active Large

Cap - ESG1S&P 500

Index

Dow Jones Sustainability

Index - U.S.

10-year Return 12.77 13.12 12.40

15-year Return 7.94 7.77 6.75

20-year Return 6.57 5.62 5.35

Source: Morgan Stanley Institute for Sustainable Investing, “Sustainable Signals”, August 7, 2017.

MILLENNIALS

Millennials, born 1982 – 2000, make up more than one-quarter of the U.S. population. With 83.1 million members, this generation outnumbers baby boomers (at 75.4 million).2 A majority of millennials believe businesses can do more to address society’s challenges in the areas of climate change and resource scarcity, and in fact stated that the primary purpose of businesses is to improve society.3

MORE RECENTLY, INTEREST IN ESG INVESTING HAS APPEARED STRONGER WITHIN TWO DEMOGRAPHICS: MILLENNIALS AND WOMEN

WOMEN

Women also have a strong interest in ESG strategies. With 80% – 90% of all women estimated to be solely responsible for their own finances at some point in their lives,4 investments in ESG strategies within this population could continue to grow.

of Millennials want sustainable investing options as part of their 401(k) plans.

90%

Offering ESG strategies in a plan menu can increase engagement with these groups, especially if the plan sponsor is seeking to attract and retain this talent pool.

ESG STRATEGIES CAN DELIVER ATTRACTIVE LONG-TERM PERFORMANCE Growth of $10K – Since Inception of the Dow Jones Sustainability Index (January 1, 1999)

Source: Morningstar. As of December 31, 2018. Indexes are unmanaged and are not available for direct investment. Investing entails risks, including possible loss of principle. Past performance is no guarantee of future results.1. US Active Large Cap - ESG is an equally weighted net-of-fee portfolio that includes all funds that meet the following criteria: Morningstar category of Large Blend, Large Growth or Large Value and deemed socially conscious by Morningstar. The number of funds that had aggregate Fund assets of at least $500 million as of December 31, 2018 included in US Active Large Cap - ESG with a 10-year track record was 33 out of 56; 15-year track record was 26 out of 41 and 20-year track record was 20 out of 27. The hypothetical analysis assumes an initial investment of $10,000 made on January 1, 1999 in the oldest share class of each respective Fund equally. This analysis assumes the reinvestment of all income dividends and other distributions, if any. The analysis does not reflect the effect of taxes that would be paid on Funds distributions. The analysis is based on hypothetical past performance and does not indicate future results. Given the potential fluctuation of each of the Funds’ Net Asset Value (NAV), the hypothetical market value may be less than the hypothetical initial investment at any point during the time period considered. See Additional Disclosures at the end of this piece, which are an important part of this presentation.

of women consider ESG factors when making investment decisions164%


The first formal position the DOL took on ESG investments, referred to by the DOL as economically targeted

investments (ETIs), was in Interpretive Bulletin (IB) 94-1. In that bulletin, the DOL established the “all things being

equal” test: As long as plan interests were not subordinated and the ETI could be expected to return a comparable

rate of return as investments with similar risks, a plan fiduciary could offer an ETI as an investment option. In effect,

plan fiduciaries could use ESG considerations to break a tie with an equivalent non-ESG option.

In 2008, the DOL added special scrutiny to ESG investing within retirement plans, effectively discouraging plan

fiduciaries from adopting these types of investments. In this guidance, the DOL ruled that investments in ETIs should

be rare, and that when they are considered, their use be documented to demonstrate compliance with ERISA.

In recent years, the DOL has concluded that its 2008 guidance unduly discouraged plan fiduciaries from investing

in ETIs or implementing ESG considerations, even when the investments were economically equivalent. In a 2015

bulletin, the DOL confirmed that, in some cases, ESG considerations have had a direct relationship to the economic

and financial value of the plan’s investment and that ESG issues are proper components of a fiduciary’s analysis

of an investment’s economic merits.5 The DOL reinstated the “all things being equal” test for incorporating ESG

considerations into an investment analysis.

Field Assistance Bulletin 2018-1 reiterates that ESG factors can be material to financial performance and may be more than

just a tie-breaker in investment decision making, but cautions fiduciaries that they should not automatically conclude that

ESG “promote[s] general industry trends or market growth” and that fiduciaries should “not too readily treat ESG factors as

economically relevant.” Therefore a key aspect for fiduciaries is determining that ESG factors are economically relevant, as

well as the importance of selecting managers that can identify ESG factors that may affect financial performance. When it

comes to the core plan menu, the DOL indicated that while replacing a Qualified Default Investment Alternative (QDIA) with

an ESG investment may conflict with a fiduciary’s ERISA duties, the addition of an ESG-themed option may not. Therefore,

plan fiduciaries may consider prudently selected ESG options as an addition to the other non-ESG portfolios on the menu.

EVOLUTION OF DOL GUIDANCE ON ESG INVESTING

ALIGNMENT WITH MISSION OR PARTICIPANT INTEREST

Because sustainability can mean different things to different investors, plan fiduciaries will likely evaluate an ESG strategy or policy in the

context of what’s most relevant to their plan, such as the company’s mission or the average participant’s interest. But the ultimate goal of

retirement plans is to ensure participants have sufficient funds upon retirement. Hence, selecting an approach that not only aligns with mission

or interest but also delivers long-term risk-adjusted returns is a crucial consideration for retirement plan fiduciaries.

COMPLIANCE WITH ERISA GUIDELINES

Some plan fiduciaries have been reluctant to incorporate ESG strategies into their retirement plan investment objectives because of concerns that

focusing on variables other than investment performance and cost may conflict with their ERISA fiduciary obligations. The Department of Labor

(DOL) has recently released guidance on how fiduciaries should, and should not, incorporate ESG considerations in their retirement plans in order

to remain ERISA compliant.

1994

‘All Things Being

Equal’ Test

2008

Special Scrutiny

Added

2015

More Supportive

Guidance from

the DOL

“ A fiduciary’s evaluation of the economics of an investment should be focused on financial factors that have a material effect on the return and risk of an investment based on appropriate investment horizons consistent with the plan’s articulated funding and investment objectives.”6

2018

Reiterating

the Need for

Fiduciary Focus


APPROACHES TO INCORPORATING ESG IN RETIREMENT PLANS

VEHICLE

Plan fiduciaries considering incorporating ESG into their plan have many choices available to them. Depending on the size of the plan,

fiduciaries may choose to incorporate ESG via a mutual fund, collective trust or separately managed account. With many investment options

now available, plan fiduciaries can select an approach that is in the best interest of their plan participants and beneficiaries:

How are ESG considerations integrated in the investment process?

What sources of data are utilized to identify and assess the ESG considerations in an investment?

How have ESG considerations impacted investment decisions?

What is your approach to active ownership, including engagement and/or proxy voting process and guidelines?

What ESG-related reporting is provided?

• Mutual Funds: The easiest way for plans to select specific

investment options that consider ESG criteria may be through a

mutual fund. At the outset of 2018, 636 mutual funds with $2.58

trillion in assets under management were subject to some form of

ESG criteria.7

• Collective Investment Trusts (CITs): CITs have become a

popular alternative to mutual funds within qualified retirement

plans, as modern CITs offer increased transparency, ease of use

and flexibility. CIT asset growth has outpaced the overall retirement

market with a 7-year CAGR of 14.4% compared to less than 9%

for the retirement market.8 Since 2012, CIT use has grown by 35%

within DC plans, while the usage of mutual funds has decreased.9

• Separately Managed Accounts: Large institutional plans may

have the scale to customize ESG investments in their offering rather

than implementing an “off-the-shelf” approach.

Regardless of the way plan fiduciaries choose to construct their

plan lineup, manager selection is crucial when considering ESG

strategies. It is important for fiduciaries to evaluate the credibility of

the investment process and the investment discipline in incorporating

ESG considerations in the investment process.

FIVE QUESTIONS TO ASK

INVESTMENT MANAGERS TO

EVALUATE ESG PROCESSES


PLAN DESIGN

Plan fiduciaries often inquire about how to incorporate ESG strategies into a retirement plan. While there are a variety of ways, we believe plan

fiduciaries may want to consider including dedicated ESG strategies on the plan menu as a standalone option, alongside non-ESG options.

Plan sponsors and fiduciaries who choose to add a select number of dedicated ESG strategies to their core plan menu have a great deal of

flexibility today within the marketplace across asset classes.

FUND MENU

EQUITY OPTIONS ESG NON-ESG

FIXED INCOME OPTIONS ESG NON-ESG

ADDITIONAL CONSIDERATIONS

MATERIALITY MATTERS

ESG factors that have significant or “material” impact on financial performance within one industry could have little or no impact in another

industry. For example, according to the Sustainability Accounting Standards Board (SASB), most environmental factors will not have a material

impact on the majority of financial companies but could greatly impact companies within the health care or non-renewable resources industries.

Material sustainable issues include those that:

• Pose direct financial risks

• Are or may be regulated in the near future

• Are becoming industry norms and drive competitive best practices

• Are raised by investors and other stakeholders and threaten brands or license to operate

• Represent opportunities for innovation and growth

Research has shown performance implications regarding material versus immaterial ESG factors. In fact, companies with top quartile

performance on material ESG factors are associated with almost 5% outperformance, whereas companies with a focus on immaterial ESG

factors has led to 2% underperformance.10

WE BELIEVE THAT ACTIVE MANAGERS MAY BE BEST POSITIONED TO IDENTIFY MATERIAL ESG FACTORS

In our view, certain passive strategies may have overly broad ESG screens, lack judgment about materiality, and fall short in maximizing returns

for participants. Active ESG strategies, on the other hand, aim to leverage multiple sources of research and data to conduct the sort of bottom-

up ESG analysis that identifies material and relevant ESG considerations, making them potentially better positioned to achieve ESG objectives

while seeking to increase financial returns.


NEXT STEPS Selecting and monitoring plan investment options and following a defined process are some of the most important plan governance duties for

retirement plan sponsors. Hence, the logical place to start is the Investment Policy Statement (IPS).

INCORPORATING ESG INTO AN IPS

An IPS often documents a plan’s investment objectives and the due diligence process for selecting and monitoring plan investments.

Consistently following the procedures set forth in the IPS and documenting those decisions has become a best practice for plan governance,

although it’s important to remember that ERISA fiduciary obligations are paramount and an IPS should be reviewed regularly to make sure it

does not conflict with ERISA obligations. If ESG considerations have never before been implemented in a plan, the IPS may need to be adjusted

to reflect how the ESG considerations will be incorporated into the investment selection process. Some aspects that should be discussed by the

investment fiduciaries and potentially addressed in the IPS include:

• Specific ESG considerations or policy. Will specific ESG

considerations or policies be adopted and what will they be? A

wide variety of ESG policies and considerations is available and

it’s important to understand the nuances of the implementation

approaches to determine fit.

• Alignment with existing investment options. Where does ESG

fit in the plan menu?

– Will there be an ESG alternative for certain or all asset classes

featured on the core plan menu?

• Roles and responsibilities. Who will determine the manner

in which ESG considerations or policy will be incorporated and

evaluated? How will investments be evaluated against the ESG

considerations or policy? What benchmarks or ratings will be used?

– Investment committee

– Plan’s financial advisor or consultant

– Third party

• Monitoring process and timeline. How frequently will ESG

considerations or policy be reviewed? Is this different from the

review of the plan’s other investment options?

• Documentation. What additional documentation will be

maintained regarding ESG, if any?

As with any aspect of the investment policy, when outlining the due

diligence process relating to the ESG considerations, it is important

to retain sufficient flexibility to adapt to changes in the industry or

plan needs.

CLOSING THOUGHTS As ESG considerations and policies are becoming more mainstream, plan fiduciaries have access to a variety

of investment options to meet the increasing demand from their plan participants and their beneficiaries.

As plan sponsors begin to encounter a new generation of savers, ESG-integrated investments provide a way

to connect participants’ sustainability preferences with the plan’s investment options while still focusing on

providing strong investment returns. As with all other plan investment options, plan fiduciaries need to be

thoughtful in understanding the various ESG investment strategies available, the credibility of their investment

processes and track records, and their tenure when evaluating them for their plan line-ups.

1 U.S. Trust, “Insights on Wealth and Work,” 2018.2 U.S. Census Bureau, “Millennials Outnumber Baby Boomers and Are Far More Diverse, Census Bureau Reports,” June 25, 2015.3 Deloitte, The Deloitte Millennial Survey, January 2014. 4 Patricia Q. Brennan and Barbara M. O’Neill. Money Talk: A Financial Guide for Women, 2014.5 Department of Labor, Interpretive Bulletin 2015-01, October 26, 2015; Fact Sheet: “Economically Targeted Investments (ETIs) and Investment Strategies

that Consider Environmental, Social and Governance (ESG) Factors,” October 22, 2015.6 Department of Labor, Field Assistance Bulletin 2018-01, April 23, 2018.7 US SIF Foundation Trends Report 2016.8 Erach Desai and Jason Dauwen. DST Systems and ALPS. Collective Investment Trusts—A Perfect Storm, March 2017.9 Callan 2017 and 2018 DC Trends Surveys.10 Khan, Mozaffar and Serafeim, George and Yoon, Aaron S., Corporate Sustainability: First Evidence on Materiality (November 9, 2016). The Accounting

Review, Vol. 91, No. 6, pp. 1697-1724 (Last revised 1 Feb 2017). Performance is from April 1993 to March 2013.

S0201 03/19 228001 ©2019 Neuberger Berman Group LLC. All rights reserved.

Neuberger Berman1290 Avenue of the AmericasNew York, NY 10104-0001

www.nb.com

This material is provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice. This material is general in nature and is not directed to any category of investors and should not be regarded as individualized, a recommendation, investment advice or a suggestion to engage in or refrain from any investment-related course of action. Neuberger Berman is not providing this material in a fiduciary capacity and has a financial interest in the sale of its products and services. Investment decisions and the appropriateness of this material should be made based on an investor’s individual objectives and circumstances and in consultation with his or her advisors. Information is obtained from sources deemed reliable, but there is no representation or warranty as to its accuracy, completeness or reliability. All information is current as of the date of this material and is subject to change without notice. Neuberger Berman does not accept any responsibility to update any opinions or other information contained in this document. Any views or opinions expressed may not reflect those of the firm or the firm as a whole. Neuberger Berman products and services may not be available in all jurisdictions or to all client types. Investing entails risks, including possible loss of principal. Past performance is no guarantee of future results.

Neuberger Berman Investment Advisers LLC is a registered investment adviser. The “Neuberger Berman” name and logo are registered service marks of Neuberger Berman Group LLC.

neuberger berman environmental, social and governance ... index dow jones sustainability index -...

Documents