3 myths about sustainability and DC

Why sustainable investing can help meet retirement objectives

More than 60% of defined contribution (DC) participants, including 76% of millennials, look favorably on investments that align with their social views.¹ Yet, DC plans, which might be expected to reflect participant preferences, lag their institutional peers in considering or offering environmental, social and governance (ESG) options:

What’s keeping plan sponsors from including sustainable strategies in their DC menus? Let’s take a step back and clear up some of the myths that may prevent some plans from looking at the options.

Myth #1: “It’s just a feel-good approach to investing”

While “feeling good” about where your investment dollars are going can be a powerful motivator to save more, that’s not what sustainable investing is about. It’s about the growing body of research that connects environmental, social, and governance-related issues to financial risk and investment opportunity. For example:

Climate change: As BlackRock’s chairman and CEO Larry Fink pointed out in his annual letter to CEOs, climate change poses several types of investment risk:

• Physical damage and business disruptions cause by climate-related flooding, fires, and other events.
• Declining valuations faced by sectors such as thermal coal producers as society transitions to different energy sources.
• Uncertainty about how to price in long-term climate change exposure for infrastructure bonds, 30-year mortgages, and other long-term exposures.

Climate change is just one example of sustainability-related concerns that have introduced unpredictability for investment managers.

Carbon footprints: At the same time, sustainability-related factors have emerged as additional screens to help identify opportunity. For example, research has shown a relationship between carbon footprint and profitability, with companies rated in the top quintile for improving their carbon footprint outperforming bottom quintile companies.

Efficiency improvement: equity performance by carbon intensity

Sustainable investing is not about feelings; it is about being aware of increasingly critical investment analytics.

Myth #2: “The DOL has put up too many hurdles”

While Department of Labor (DOL) guidance has stated that sustainability cannot be the primary consideration when choosing investment options, it can be used as a “tiebreaker” between essentially similar options.

Fortunately, that hurdle may have become easier to clear as advanced data, more efficient implementations, and increased scale have improved results. The following charts compare returns for US, global, and emerging market indexes against alternatives that tilt the index’s exposure to favor companies with stronger ESG scores.

US large and mid-cap equities

Global large and mid-cap (non-US) equities

As can be seen, ESG Indexes have performed at parity, or in some cases more strongly, than the parent indexes.

Myth #3: “Sustainable options are limited to specialty strategies"

In his CEO letter, Larry Fink stated, “We believe that sustainability should be our new standard for investing.” If, as we believe, sustainability is increasingly important for identifying critical risks and return opportunities, it would be poor fiduciary practice on our part to limit sustainable implementations to specialized options.

Fortunately, there are a number of ways to include sustainability objectives in investment analysis, ranging from the broadest applications to the highly focused. They include:

• Baseline screens: They are designed to exclude companies or industries associated with specific activities. They can be applied to an index or a primary screen for an active manager.
• ESG optimizations: Similar to the ESG Indexes in the charts above, a parent index can be weighted to favor companies with positive environmental, social, and/or governance ratings.
• Thematic trends: Investment strategies may attempt to capitalize on specific transformative sectors, such as sustainable energy or transportation, that are expected to benefit from long-term sustainability-related trends.

At an even more basic level, as research into sustainable investing grows, as more and more investors move into the space, and as improved data becomes available, sustainability factors will increasingly sit alongside traditional investment metrics.

Sustainability and retirement investing

One final point on why DC plan sponsors should look at sustainable options: Risk and return drivers captured through the sustainability lens are quite often very long term. We’ve mentioned the challenge of pricing climate risk for mortgages and infrastructure bonds, and the potential of some transformative industries.

These long-range exposures and opportunities are aligned with the time horizons for the average participant. A 30-year-old participant may expect to be invested in their workplace retirement plan for 50 or 60 years. It is highly possible – even likely – that sustainable investment themes will affect their journey – and possibly their outcomes. That’s why we believe the time is now to take action to protect the future that participants are saving for.

Please contact your BlackRock relationship manager to learn more about our sustainable investment options.

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