The Retirement Market: An Ocean of Opportunity
The executive order on retirement savings, which President Trump signed on Friday, shines a spotlight on corporate-sponsored retirement plans. The $28.0 trillion U.S. retirement market offers opportunities for growth in environmental, social and governance (ESG) assets under management (AUM), particularly among corporate-sponsored retirement plans.
60% of corporate plan sponsors that participated in a recent NEPC survey indicated that they were not interested in incorporating ESG investing, which means considering ESG factors in both investment decisions and ownership policies and practices.
Of plan sponsors that incorporated ESG investing, 70% were defined contribution plans, or plans in which benefit payments to retirees depend on investment returns. Nevertheless, fewer than 10% of 401(k) plans—a type of defined contribution plan—offer ESG investing options. An even smaller 6% of defined contribution plan sponsors, or those promising a specified monthly benefit at retirement, incorporate ESG. Accordingly, corporate-sponsored retirement plans are a relatively uncontested market space, or blue ocean, for ESG fund managers.
Headwinds from Insufficient Data and Training
Of the 60% of corporate retirement plan sponsors that are not interested in ESG, over a third solely focus on financial factors when making investment decisions and over a quarter need more data to evaluate the impact of ESG factors on financial performance. Accordingly, future growth in ESG investing in the $5.3 trillion 401(k) market and more broadly the $10.3 trillion U.S. defined contribution and private-sector defined benefit plan markets will depend in part on improving data on the relationship between ESG and performance and educating plan sponsors about ESG.
Shifting Regulatory Sands
Department of Labor guidance on ERISA has ebbed and flowed on ESG factors along partisan lines since 1994. By way of background, ERISA establishes minimum standards that govern the operation of private-sector employee benefit plans. Most recently, the Department of Labor Field Assistance Bulletin 2018-1 restated that ERISA fiduciaries may not assume greater risk or sacrifice returns to pursue social or environmental goals. Future updates to this guidance could expedite or slow the growth of ESG retirement savings AUM.
Demographic Tailwinds from Millennial Investors
The 87% of millennial high net worth investors who are interested in ESG and the 28% who make ESG investments represent demographic tailwinds behind growth in ESG retirement assets. Millennials are projected to overtake baby boomers in 2019 as the U.S.’s largest living adult generation, millennial retirement AUM should grow as they enter their peak earnings years, and 94% of millennials who are eligible to participate in employer-sponsored retirement savings plans do so. Millennial ESG retirement assets should grow when the two-thirds of millennials who have saved nothing for retirement yet and the broader 95% who have saved inadequately for retirement enter catch-up mode.
Other Tailwinds: More Than Just Demography
Millennial interest in ESG investing is farsighted. The youngest millennials, born in 1996, will on average retire in approximately 45 years and pass away in 60. Over that time horizon, if 97% of the actively publishing climate scientists who agree that climate change is due to human activities are correct and if the net damage costs of climate change are indeed pronounced and do indeed grow, sustainability should become central to investment decisions. Mary Jane McQuillen, Head of ESG and Portfolio Manager for ClearBridge Investments, explains that “the deliberate sustainable future and investment return intentions of ESG investing is a natural fit for the long-term horizon of pension plans.” Indeed, global public opinion already ranks the threat of climate change as a close second to the threat of ISIS.
In addition, intangible assets, including goodwill, intellectual property and brand, represent 87% of current market value. This makes how companies build relationships with their communities, customers and workforce critical to investment decisions.
A Rising Tide Lifts All Boats
The growth in millennial assets, heightened awareness of environmental and social factors, and the impact of the growing share of intangible equity value all represent a long-term rightward shift in the demand curve for ESG investing. Improving ESG data and raising awareness of ESG among plan sponsors should further this rightward demand shift.
Low ESG penetration in the corporate employer-sponsored retirement market represents an opportunity for new and entrenched competitors to grow supply of ESG retirement funds to meet this increased demand. Indeed, the blue ocean of ESG retirement funds should be a welcome reprieve from the red ocean—or contested market space—of much of the rest of the asset management industry.