Should your 401(k) have socially responsible investment options?

The meaning of the term socially responsible investing (SRI) continues to evolve as 401(k) plan participants look to align their investment portfolio with their values. More conversations around environmental, social and governance investing (ESG) are happening. And that’s coming not just from the youngest generational demographics in the workforce but from all generations.

“Interest in ESG investing is broad,” says Jim Altman, Middle Market Pennsylvania Regional Executive at Huntington Bank. “Plan participants of all ages are asking more questions about how companies behave, their impact and their intentions.”

Smart Business spoke with Altman about socially responsible investing and what employer plan sponsors should know.

What is socially responsible investing?

SRI had typically been concerned with a couple things. One is negative screening, something that’s most common with faith-based organizations — they might decide they won’t invest in companies that deal in tobacco, alcohol or firearms, for instance. The other dealt with environmental concerns and is what most people think about when they think about SRI. But environmental concerns don’t just mean solar panels and windmills. SRI now also includes environmental, social and governance investing (ESG), which, puts the focus on those elements, though each area of interest can mean something different to each investor.

What should employers know before adding ESG investment options to a 401(k)?

While some employer plan sponsors might be eager to include ESG options in the portfolio to capture the interest of socially conscientious investors, there is good reason to approach the initiative with caution. Adding ESG options to a plan could signal to some that the employer’s belief system is showing itself in that decision, and that has ramifications. A plan sponsor that constricts investments to only ESG options could find themselves the target of criticism by plan participants if the investments are seen as politicized or impinging on someone’s religious views.

The best approach is think in terms of complementary strategies. Don’t get rid of a fund in a lineup just to add an ESG option. Instead, introduce ESGs as new offerings that complement the existing plan.
It’s also a good idea to have an open conversation among stakeholders about changes to the plan rather than leadership making the sole decisions. Be collaborative and document the process to defend the position that’s reached regarding ESGs.

How might including ESG investment options in a 401(k) plan affect plan performance or participation?

There tends to be a negative connotation of how ESGs affect plan performance, mainly because of embedded SRI ideas that, at their extreme, completely exclude certain industries, such as fossil fuels. Adhering to such a strict portfolio could lead to underperformance. However, as ESG ideas have progressed, it’s less about excluding industries or companies and more about considering the direction of those businesses. For example, a fossil fuel company might pump oil but its R&D for wind, solar and other sustainable sources of energy are on the cutting edge.

Participation in employer-sponsored plans hasn’t shown a drop off when a plan lacks ESG-offerings. Part of that has to do with the fact that most plan participants use the default vehicles — target-date funds for example — when they enroll in a 401(k).

How have asset managers adjusted their plan offerings to accommodate socially responsible investing?

Asset managers that sponsor 401(k) plans are becoming more ESG-minded. Some are integrating ESG options into all funds almost by default. There could soon be ESG-dedicated strategies as well as plans in which ESG options are integrated with more mainstream options. Increasingly, the demand for ESG is there from a participation standpoint, but not all asset managers have brought those options into their plans.
ESG investing is a growing and worth-while discipline in investment management. Employers shouldn’t be afraid to tread into this area, but should do their research before acting.

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