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October 03, 2011
Pension Funds in US Slow to Add Sustainable Investment Options
    by Robert Kropp

US SIF survey of ESG uptake by defined contribution plans reveals that while most respondents have little or not understanding of sustainable investment, most expect an increase in interest in next five years.

The conclusions of the groundbreaking Fiduciary II report of 2009—that "Advisors to institutional investors have a duty to proactively raise ESG (environmental, social, and corporate governance) issues within the advice that they provide, and that a responsible investment option should be the default position"—followed the more conservative conclusions of its 2005 predecessor, the Freshfields report.

While Freshfields concluded that the consideration of ESG criteria falls within the bounds of the fiduciary duty of asset owners, it also concluded, in the words of a recent report, that "pension funds' fiduciary duties…only permit the consideration of an ESG criterion, if this process has no detrimental financial effects."

On the other hand, according to the report, an academic paper authored by Hoepner, Rezec, and Siegl, Freshfields also determined "that pension funds are legally required to consider an ESG criterion, if there is a clear consensus amongst beneficiaries in favor of this criterion or the criterion is believed to be financially beneficial."

In their paper, the authors propose "a realistic prudent investment test" by analyzing over 1,500 firms from 26 developed countries over a 77-month period, using corporate responsibility ratings supplied by EIRIS, and conclude "that pension funds' fiduciary duties do not appear to prohibit the integration of environmental responsibility criteria into their investment processes."

Indeed, the authors continue, "Our results provide zero indications that the integration of aggregated or disaggregated corporate environmental responsibility criteria into investment processes has detrimental financial performance effects for pension funds concerned about the environment. Not a single portfolio with an average or above average degree of environmental responsibility underperforms its benchmarks at any common significant level."

Such findings give context to a recent survey of uptake by defined contribution (DC) pension plans in the US of sustainable investing options for their participants. While inclusion of such options were reported by 14% of respondents—they numbered three percent of the 13,000 plans contacted for the survey—an additional 13% are either discussing a sustainable investment option or intends to add such an option within two to three years. Eighty-four percent expect that demand for such an option by participants will increase or at least remain constant over the next five years.

The findings of the survey, commissioned by US SIF: The Forum for Sustainable and Responsible Investment and authored by Mercer, dovetails somewhat with the academic paper by Hoepner et al, when the former asks respondents to describe barriers to adding a sustainable investment option to their offerings. The most common reason given was lack of participant request, but the second most often cited reason was fiduciary concerns.

"For this group of plan sponsors, fiduciary concerns may overlap with, and stem from, their perception that SRI funds underperform," the report states. "It seems reasonable to suggest that if plan sponsors were more aware that SRI funds in general do not underperform non-SRI funds of similar asset classes and styles, their fiduciary concerns would lessen."

The respondents, the majority of which were corporations offering 401k plans, also acknowledged in almost 60% of cases that they had little or nor understanding of sustainable investment products and indices. On the other hand, non-profit, mission-based, or public organizations in which a sustainable investment philosophy is more likely to be embedded in the culture were more likely to provide such options in their offerings.

When the question of what needs to be addressed before sustainable investment options become more widespread, the unfamiliarity with the practice becomes more evident. More than 60% of respondents said that further demonstration of comparable performance would be needed, and another 40% sought clarification of fiduciary duty. Perhaps the academic report by Hoepner et al might represent a first step in providing such assurance.

Principals involved in the report acknowledged that a better understanding of sustainable investing by providers of defined contribution plans is an essential element in the uptake of the practice. Craig Metrick, US Head of Responsible Investment for Mercer, said, "Given the large number of plan sponsor respondents who admit to little or no knowledge of SRI products and indices, education is clearly a critical and a significant opportunity."

And Lisa Woll, US SIF CEO, said, "The retirement industry regularly analyzes the overall investment composition of DC plan assets; however, plan sponsors and participants have had little concrete information about the availability of sustainable and responsible investing options."


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