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The Case Against ESG in Plan Lineups—Part 1

Despite increasing popularity, ESG faces many head winds, namely modest adoption in retirement plans and mixed returns.

At times it seems sustainable, sustainable/responsible or ESG (environmental, social and governance)–focused investing has taken over the world. Consider some recent stats on ESG’s growing role:

  • According to Morningstar, “Assets in U.S. sustainable funds have stayed on a steady growth trajectory. As of September 2021, assets totaled more than $330 billion. That's a 9% increase over the previous quarter and 1.8 times the $183 billion from the third quarter of 2020.”
  • Ernst & Young’s 2021 Global Alternative Fund Survey reports that 39% of investors are currently invested in ESG products, up from 33% in 2020.
  • Bloomberg Intelligence projects ESG assets to reach $41 trillion by the end of 2022.
  • Deloitte estimates that “At their current growth rate, ESG-mandated assets (defined here as professionally managed assets in which ESG issues are considered in selecting investments or shareholder resolutions are filed on ESG issues at publicly traded companies) are on track to represent half of all professionally managed assets globally by 2024.”

Reported amounts in ESG-focused funds differ depending on how they’re defined but the overall trend is clear: ESG is attracting assets. Anecdotally, I’ve noticed two additional trends accompanying the growing cash inflows. First, the infrastructure behind ESG investing—the ESG industry—also is expanding rapidly. Every firm appears to be hiring specialists to build out its ESG investment management and marketing teams. Second, the superiority of ESG/sustainable investing is accepted as gospel among its adherents, who usually maintain that research consistently supports their position. They have zero doubts that ESG is not only the right thing to do for the world, but that it also offers investors enhanced risk diversification and realistic potential for improved returns.

Maybe Not

But there are skeptics. A recent Barron’s article discussed how ESG portfolios’ avoidance of energy and defense stocks resulted in poor first quarter 2022 results and benchmark underperformance. The writer stresses that one quarter’s results do not constitute a trend, but the article’s sources make their case that in coming years ESG is likely to face multiple challenges that could diminish its appeal.

A February 2022 Institutional Investor opinion piece by Andrew A. King and Kenneth P. Pucker, ESG and Alpha: Sales or Substance?, raised additional concerns. King, a professor at Boston University, and Pucker, a lecturer at Tufts University, review the history of ESG investing and critically examine what they call the four main claims about ESG performance: “It produces higher profits, signals higher stock returns, lowers capital costs, and attracts investment flows.”

King and Pucker’s conclusion throws cold water on the added-alpha argument: “We learned that the logic and evidence for assurances of ESG-driven alpha are lacking. Indeed, it is our best guess that flows of money into ESG funds represent a marketing-induced trend that will neither benefit the planet nor provide investors with higher returns—but might defer needed government regulation.”

Research Challenges

If you want to dive into a statistically oriented academic study on ESG’s purported benefits, Ulrich Atz at New York University and several co-authors reviewed over 1,100 peer-reviewed papers and 27 meta-reviews published between 2015 and 2020. The authors report: “In contrast with research from management and related disciplines as well as findings purported by industry reports, we did not find an outsized financial return for ESG strategies. The bulk of studies concluded that there was either no statistical difference compared to a conventional benchmark or that results were positive and negative (i.e., mixed) within a study.”

Atz and his co-authors don’t rule out potential ESG benefits, but they caution that the research methods need to evolve to provide clearer answers: “While we appreciate the want for an overall, universal result on whether ESG delivers or not, we emphasize again that it is the details and mechanisms of the relationship between sustainable investments and financial performance that matter more. For one, we suggest that the classification of sustainable investment strategies is ambiguous, and so future research, which carefully assesses the different ESG strategies, ought to provide us with richer findings.”

Modest Adoption

Retirement plan sponsors largely are taking a cautious approach to ESG. Part of that reluctance certainly stems from what Bonnie Treichel, founder and chief solutions officer at Endeavor Retirement, calls the “perceived regulatory ping pong with the DOL” as its position on including ESG in retirement plans has changed with different administrations. An early 2022 survey by Russell Investments of its U.S.-based consulting clients supports Treichel’s assertion. The survey found that “half of plan sponsors reported changing DOL guidance as a consideration” in their ESG evaluations.

The inclusion of ESG options in retirement plans remains low. The Russell Investments survey reported a mixed bag of ESG initiatives and results, according to a May 12, 2022, blog post by Kerry Galvin:

  • Fewer than one-third of plans reported that they have either implemented or are planning to implement some level of ESG considerations into their investment process/investment due diligence. 
  • Over half of respondents reported having conducted ESG education over the past two years.
  • About one-third of plans noted a lack of evidence of ESG performance as impacting their willingness to consider ESG.
  • Inclusion of ESG options in defined contribution plan menus is limited with only two plans among those surveyed currently offering an ESG option to participants. However, plans may include a self-directed brokerage window through which plan participants can directly access ESG-related investments.

Callan’s 2021 ESG Survey also found low ESG-adoption despite growing interest. According to a November 5, 2021, blog post by Callan’s Thomas Shingler: “The (ESG) survey also highlighted data from the proprietary Callan DC Index and the Callan DC Survey and reported that 13% of DC plans offered a dedicated ESG option. Usage remained low, however, with an average allocation of 1.2%.”


Part 2 of this article will discuss an approach to evaluating ESG options for plan lineups and some advisors’ reasons for not including ESG.

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