Today’s word of the day is “pecuniary.” If you have never used that word, the online Oxford Dictionary definition is “relating to or consisting of money.” With the Oct. 30 release of the Department of Labor’s much awaited “Final Rule on Financial Factors in Selecting Plan Investments,” pecuniary and it’s negative, nonpecuniary, have attained prominence in retirement plan business. The rule, which revised the department’s first proposal dated June 23, will take effect on January 12, 2021. While the new rule could cause headaches with ESG investments for some advisors and plans, some observers believe the impact will be modest for most plans and may even benefit ESG inclusion in plans.
A Shift in Focus
The original proposal focused on ESG-themed (environment, societal and corporate governance) investments and their use in ERISA plans. Interested parties submitted over 8,000 comments in response, with a large majority raising concerns and objections. In response, the final rule does not get into details on ESG-themed investments. Instead, it refines the definition and role of the pecuniary factors fiduciaries must consider when selecting plan investments. To reduce potential confusion, the ruling provides a definition: “The term pecuniary factor means a factor that a fiduciary prudently determines is expected to have a material effect on the risk and/or return of an investment based on appropriate investment horizons consistent with the plan’s investment objectives and the funding policy established pursuant to section 402(b)(1) of ERISA.”
In other words, the evaluation of investment factors that influence risk and return remains primary, which won’t be a change for many plan advisors and their plan clients. The DOL’s definition and review process prohibit decisions in which nonfinancial considerations are given higher priority than financial factors because that subordinates plan participants’ interests.
ESG as a Pecuniary Factor
Nuveen, a TIAA company, considers ESG as a subcategory under the broader “responsible investing” (RI) umbrella. The company’s “Fifth Annual Responsible Investing Survey” surveyed affluent investors and financial advisors in December 2019 and January 2020. The findings revealed that the DOL’s revised ruling reinforces many investors’ and advisors’ prevailing perspectives on RI. For example:
- For the first time, a majority of investors (53%) cited performance as their main motivation for investing in RI. Eighty-five percent of investors said they would invest in RI only if the returns were the same or better than non-RI alternatives.
- Nearly one-third (32%) of advisors said in the past year, portfolios with RI have yielded above market-rate returns, compared with just 12% and 4% in 2018 and 2017, respectively.
- Seventy percent of advisors cited superior risk management and better performance as top reasons why their high-net-worth clients invest in RI, compared with 39% in 2018.
In a recent webinar, Nuveen’s Amy O’Brien, global head of responsible investment, highlighted three reasons why responsible investing can lead to better-informed decisions:
- Generates alpha: ESG-integration may enhance the long-term financial performance of companies
- Manages risk: Incorporating ESG allows for better downside risk management
- Creates opportunity: Uncovers new investment opportunities though positive social and environmental impact.
Jennifer DeLong, head of defined contribution, and Michelle Dunstan, global head—responsible investing with AllianceBernstein LP recently posted a blog post, “DOL’s Revised DC Investment Rule Removes Potential ESG Sticking Point,” summarizing the position that ESG-considerations are financial/pecuniary considerations. As an example of ESG-inclusive analysis, DeLong and Dunstan cite a hypothetical company that emits large amounts of carbon and is exposed to carbon taxes, which are likely to increase with time. Additionally, mandates to upgrade equipment could force the business to face higher operating costs.
The authors maintain: “When the bottom line is achieving better financial outcomes, plans can and should take an ESG integration lens across the investment lineup. For DC plan sponsors, we think ESG considerations should be front and center in seeking to promote better financial outcomes for participants—and invest for purpose in the process.”
Advisors’ and Plans’ Perspectives
From plans’ perspective, DeLong and Dunstan say that the final rule clarifies that ESG factors are financial factors and that they are acceptable for use in DC plans. They believe this has been an area of confusion for plan sponsors, consultants and advisors given past guidance. “The DC community needs to continue to be educated on how integrating ESG factors into the investment management process can and should be a critical component of fundamental in-depth research in investment solutions—whether or not an investment is ESG-themed,” they add.
The plan consulting industry has matured, according to Brendan McCarthy, head of DCIO at Nuveen. Professional consultants are likely to put every prospective investment, ESG-themed or not, through intensive due diligence and scrutiny before it is even considered for a plan’s 401(k) menu. The DOL ruling codifies existing rules and guidance relative to investments, he notes, which will lead consultants to ensure their clients’ plans are in compliance. “I think consultants are going to take this rule, look at it and ensure that their investment due diligence process meets all of the components in the rule,” he says. “And that's not just going to be specific to ESG investments—that will be all investments across their plan. They'll take it as an opportunity just to double-check their investment process, that it's meeting all of the requirements under the new rule. Plan advisors really have an opportunity with this new rule to show their value to their plan sponsor clients, both existing and prospective.”
