Even as the Trump administration actively discourages environmental, social and governance investing in employer-sponsored retirement plans — a rule the Biden administration may overturn — it’s not like investors had a lot of ESG choices to begin with.
When Morningstar looked at lineups for defined-contribution plans like 401(k)s or 403(b)s , the research firm found only 4.5% of these plans offered at least one sustainable fund — that is a fund that intentionally incorporates ESG.
But for those who want to invest that way, there are ways to do it within the company-sponsored retirement plan. It just takes some legwork to find them.
Socially responsible funds have been around since the 1980s. But most were so small that adding them to a company’s defined contribution could overwhelm the fund, says Michael Young, manager of education programs at US SIF, a sustainable investing advocacy group.
Now, though, more investors who want to align their investments with their values are seeking ESG funds. Assets under management have swelled in some of the biggest mutual funds and exchange-traded funds. And contrary to longstanding myths, these investors aren’t sacrificing performance. For 2020, many sustainable funds performed well, with 72% of sustainable equity funds ranked in the top halves of their Morningstar categories, and all 26 ESG index funds outperformed their conventional index peers.
Even so, plan sponsors are usually cautious to add new offerings in 401(k) or 403(b) plans unless employees make requests.
Without that, what can investors do?
The first possibility is to see whether the company’s 401(k) plan includes a brokerage option. If so, you can access ESG investments through a brokerage platform, says Jon Hale, head of sustainability research for the Americas at Morningstar.
It’s also possible that your plan offers some ESG-like funds. Some fund managers are starting to consider ESG metrics in their strategies. While not pure ESG funds, more of these “ESG consideration” funds are popping up in retirement plans; the Morningstar research showed about 22% of defined-contribution plans had at least one offering.
To find those funds will require a bit of extra reading. That information can be found in the fund’s statement of additional information, available either through the 401(k) site or the fund company itself, says Dmitriy Katsnelson, deputy chief investment officer for Wealthspire Advisors. Information on proxy voting and other shareholder advocacy also can be found there.
If those two options aren’t available, look for funds popular with 401(k) plans that get high sustainability marks from sustainability researchers, even if the fund’s managers aren’t intentionally investing that way. It takes some research using third-party information to dig into the fund’s holdings, and investors may have to settle on one of the ESG factors since sustainability is incidental to the process.
Young says investors can start by using free, public tools to start screening conventional funds and stocks for their ESG ratings. Morningstar and As You Sow’s Invest Your Values both rate funds and ETFs, while Sustainalytics (owned by Morningstar) and MSCI rate public companies’ ESG risks.
Investors screening conventional funds should remember that these ratings are snapshots in time, Katsnelson says. Holdings can change, which might eventually affect a fund’s ratings.
Hale says Morningstar’s sustainability rating is based on the previous 12-months’ worth of holdings. “It doesn’t mean the fund is trying to be sustainability-focused, but it does mean that its current holdings have lower ESG risk,” he says, noting that a lot of funds don’t change their holdings that much.
Greg Wait, an adviser at Milwaukee-based Riverwater Partners who actively works with retirement plans on selecting responsible investments, says that since there’s no one definition of sustainability, investors will find some ratings differences between the screeners. In that case, he says, look for some consensus.
Conventional funds with higher ratings
None of the 100 most-common mutual funds found in 401(k) plans, based on assets under management, are ESG funds, Wait says. But a few stand out for having high incidental sustainability ratings.
Since the 1950s, American Funds’ Washington Mutual Fund AWSHX, -1.04%, a large-cap value fund, has screened out tobacco and alcohol companies, he says. As You Sow also gives the fund an A rating – its highest – for gender-equity and for not owning gun manufacturers. However, it holds several fossil-fuel-related companies.
Fidelity’s large-cap growth Contrafund FCNTX, -0.63%, earns a low-carbon rating from Morningstar. Neuberger Berman’s Genesis Fund NBGNX, -1.85%, a small/mid-cap growth fund, gets five globes from Morningstar, the top rating, and a mix of mostly A and B grades from As You Sow.
Wait flags fund family T. Rowe Price as a choice for sustainably minded investors, noting the firm has a “responsible investing indicator model ” and integrates it into its investment process to find material ESG risks and long-term corporate sustainability.
Many of T. Rowe Price’s conventional emerging-market funds get high sustainability marks from Morningstar, and some of their conventional midcap funds are highly rated, such as T. Rowe Price Diversified Mid-Cap Growth fund PRDMX, -0.63%, which gets four globes and low-carbon rating and on a 15-year basis has returned 11.2%, landing it in the top half of its Morningstar category.
Generally, large-cap and technology funds are likely to get higher sustainability ratings because large companies over the past few years have taken on some environmental sustainability programs, and tech companies often have few dealings with tobacco, weapons or fossil-fuel companies.
But that doesn’t mean tech companies don’t have their own low marks on some ESG measures, Young says. MSCI gives Facebook FB, -0.50% poor ratings on social factors such as privacy issues and corporate behavior, but high ratings on carbon emissions. Tesla TSLA, -1.28% gets high points from MSCI for being clean tech, but low ratings for labor management, and has seen its ESG rating slip over the past few years. Those two examples are why ESG-minded investors may want to spot-check some of the top-10 holdings of conventional funds after their initial overall fund screens.
Hale recommends that investors who want to know the financial material risks for different sectors look at the Sustainable Accounting Standards Board’s materiality map.
Young says there are no ESG choices in the default option for most 401(k) investors — target-date funds — and the DOL rule specifically makes it hard to include those. However, that could change under a Biden administration.
He also points out that about 3 1/2 years ago, asset-manager Natixis introduced Sustainable Future Funds, the first intentionally sustainable target-date fund series. These have performed strongly on a three-year basis, beating 94% of their peers. He says that could be something to watch, especially if performance is strong once it passes its fifth birthday, a milestone most plan sponsors look for when considering adding funds. That could mean these start showing up in plans then.
“If it continues to outperform, you’re going to see more plans saying, ‘hey, that it’s two birds with one stone for us and improves performance,” Young says.
Debbie Carlson is a MarketWatch columnist. Follow her on Twitter @DebbieCarlson1.