Investing for the Future: The Trade-offs of Investing in Environmentally Conscious Retirement Funds

Sustainable investing means more than going paperless with your monthly statements. It means that you are putting your money to work with managers who understand and subscribe to socially responsible investing (SRI). There are a growing number of funds who consider the environmental, societal and governance (ESG) impacts of their investments. ‘Socially responsible’ is a bit of a subjective term, so how can we be sure that your idea of sustainable aligns with the funds you invest in?

Morningstar Investment Research has developed a system to rank funds based on their sustainability, and some funds even operate under an ESG mandate. Sustainability rankings are derived from the Sustainalytics scores given to each of the funds’ underlying holdings. Each holding is ranked on a scale of 0-100 based on how well they address ESG related issues relative to their global industry peers. An ESG mandate means the fund has a stated goal of seeking responsible or sustainable investments. While the ESG mandate is growing, only 2% of funds currently serve with this explicit goal. Although the mandate is not common, there are still a number of funds that receive a high sustainability score from Morningstar.

At Twelve Points we have been approached by environmentally conscious investors asking to mimic our traditional proposed retirement funds with sustainable funds. After researching the available options, we were able to assemble an offering mirroring our traditional allocation with a majority of funds embracing an ESG mandate. In areas where an ESG mandated fund was not available, we selected funds with top ranked Morningstar sustainability scores.

The sustainable investing space is still young and the unique service that the ESG mandated funds provide comes at an increased cost.The chart below with information provided by Morningstar compares the share class weighted average expense ratio for ESG funds vs. their non-ESG global industry peers.

The actual discrepancy between the expense ratios may be even larger than the chart demonstrates when one considers that the data above takes into account share classes in non-ESG funds with higher costs than our standard investment in Institutional share classes. ESG mandated funds are small and more likely to only have only one share class. Furthermore, these small cost differences make a significant impact when considering the compounding effects over a 30 year (or more) period.

A recent development in the ESG investing space is the creation of the first ESG mandated Target Date Fund. Natixis Global Asset Management, who is launching the fund, stated in an SEC filing that portfolio managers will look for, “fair labor, anti-corruption, human rights, fair business practices and mitigation of environmental impact, seeking a diversified portfolio of investments that contribute to a more sustainable future”. The Natixis target date funds are included in the Twelve Points sustainable 401(k) fund offering.

As the sustainable investing trend grows and expense ratios for the investment funds become competitive with their non-mandated peers, we intend to incorporate them into our standard 401(k) offering. We currently look for the best combination of expense ratio, performance and risk for a given asset class. Sustainable investing has not reached the point where it is generally in our clients’ best interests to be placed in an ESG fund without their specific request.

While the funds we allocate to aren’t necessarily burning coal and chopping down trees in their free time, they do not specifically state that they have a goal of responsible investing. As the divergence of key performance metrics closes, the options and competitiveness of sustainable offerings will become more appealing to the average investor.