Socially responsible 401(k) options show employers take DEI seriously

Lately, senior management at businesses like yours has been feeling the need to get serious about diversity, equity and inclusion (DEI) and other socially responsible policies and practices.

In a post on HRMorning.com, experts Stephanie Ashton and Monem Salam said this is how they’re putting their money where their mouth is:

One way for employers to demonstrate that diversity and social impact matter is through the investment choices in employee retirement plans, such as a 401(k).

Over the years, as the U.S. workforce has become younger and more diverse, expectations around the issues and values an investment should address have shifted – and there are more socially responsible and sustainable investment options to cater to this shift.

Socially Responsible Investing, or SRI, is a term that is often used somewhat interchangeably with “ethical investing,” “impact investing” and “sustainable investing.” These concepts all reference the core idea that companies that demonstrate stronger performance in the areas of environmental, social and governance (ESG) criteria make more desirable investments based on ethical principles, financial measures, or a combination of the two.

Though SRI traces its roots as far back as the 18th century, there are some persistent myths about it. The process of moving a company’s 401(k) to a more sustainable option can be tricky, but it’s achievable. It also demonstrates a true alignment of your company’s mission and values. Here are four myths about SRI and the reality.

Myth 1: SRI is niche or fringe

Although SRI has been sometimes regarded as a niche market or a fad, the number of investors adopting ESG strategies suggest otherwise.

In the five years between 2014 and 2019, a Morningstar report on the landscape of U.S. sustainable funds showed the number of mutual funds branded as sustainable increased by over 140%. The Forum for Sustainable and Responsible Investment (US SIF) found that as of 2020, one out of every three dollars under professional management in the U.S. was managed according to sustainable investing strategies. Most fund managers have at least one – if not a whole menu – of different socially responsible or sustainable funds to choose from.

Among institutional investors – insurance companies, pension plans, and other major players on Wall Street – a 2019 survey from Morgan Stanley found that 57% envision a time when they will only allocate investments to managers with a formal sustainable investing approach. Their recent Sustainable Signals research on individual investors shows the demand for sustainable investing is even greater:

• 50% of investors, and 73% of millennials, made changes to their investment portfolios or plan to within the next 12 months in response to social justice issues.
• 79% of all individual investors, and 99% of millennials, are interested in sustainable investing.
• 76% of investors cite performance concerns as the biggest barrier to investing sustainably.

Myth 2: SRI investing delivers lower returns

The myth that sustainable investing delivers lower returns to investors has been hard to shake. But researchers at New York University’s Stern Center for Sustainable Business found improved financial performance due to ESG becoming more noticeable over a longer time and that ESG can provide downside protection to investment portfolios, particularly during social or economic crises.

Morgan Stanley found that U.S. sustainable equity funds outperformed traditional peer funds by a median total return of 4.3% and reduced investment risk during the first wave of coronavirus in 2020. And though outperformance can be challenging to predict, sustainable funds tend to favor higher-quality investments that, according to Kenneth Lamont of Morningstar Europe in a July 2021 Financial Times article, “may reasonably be expected to outperform the market over long periods.”

But the persistence of the myth of lower performance is precisely why socially responsible and sustainable options are so hard to find in employer-sponsored retirement plans. The Plan Sponsor Council of America found in 2019 that 2.9% of 401(k) plans had even one ESG or sustainable fund as part of the menu.

Myth 3: ERISA doesn’t allow SRI investments

The fiduciary standards an employer must abide by when selecting appropriate investment options for employees is a high standard to clear.

But the Department of Labor says “ESG factors, and climate change issues in particular, pose financial risks that plan sponsors should consider as prudent fiduciaries.”

Academic research and industry experts alike point out that sustainable funds perform just as well – if not better – than other funds, a view shared in the Institutional Shareholder Services survey in 2021.

Myth 4: DEI and SRI investing are separate issues

There’s a final angle to consider about adding SRI options to a 401(k) menu: Adding socially responsible and values-based options to your retirement plan menu can be an actionable, meaningful DEI initiative that demonstrates an employer’s commitment to equity and inclusion.

This can help employees recognize that your commitment to sustainability and social justice goes beyond lip service and may inspire greater loyalty to the company – as well as greater participation in the company’s 401(k). And even just one SRI option may cover a lot of ground.

It may also be worth surveying your staff to see how many wish to have these options in your plan.

In the end, a values-based approach to retirement savings might be more than just a way of retaining and engaging employees. It could help attract new talent as well.