How to shape a socially conscious 401(k) strategy

ESG funds can help, if you can persuade those who decide.

If you want to make a big difference in the world using your hard-earned money, you don’t have a lot of tools at your disposal if you’re not extremely wealthy.

But everyday people have an untapped multimillion-dollar advocacy opportunity staring them in the face each pay period: workplace retirement plans that haven’t added socially responsible investment funds.

Just 2.9% of 401(k) plans have even a single fund dedicated to environmental, social and governance issues, according to the Plan Sponsor Council of America’s most recent member survey. If your retirement money is not stashed in one of these so-called ESG funds, you probably have invested in companies that extract or refine pollutants, mow down rainforests or mistreat people or animals. And that means that you’re endorsing their work with your dollars.

If this makes you uncomfortable, you stand a good chance of fixing it. It’s not simple or quick. But if you are resolved to, say, do something about climate change in 2020, diverting millions of dollars in retirement money from companies that warm the planet isn’t a bad place to start.

So first, a bit about how things work. Someone (or a committee of people) at your employer either picks or approves the lineup of mutual funds for your retirement plan. Ask a human resources person — or the president, chief financial officer or executive director at a smaller organization — and you’ll soon have a name or names. Now rally your likeminded friends (the more the better) and get ready to make your case.

Those plan’s deciders answer to you, in theory — and their interests are aligned with yours, given that everyone wants to have a great plan with good choices. But this is where it starts to get complex.

These colleagues are supposed to act as fiduciaries when the federal regulations are in play, choosing funds only after a careful process that puts employees’ interests first. The Department of Labor, which oversees these plans, sensing the growing interest in ESG investing, offered some guidance for the deciders in 2018: “Fiduciaries must not too readily treat ESG factors as economically relevant” and should focus on “financial factors that have a material effect on the return and risk of an investment.”

This can make plan-deciders jittery because of the persistent belief that socially responsible funds tend to do worse than the broader market or the niche that they inhabit.

If you hear this argument, point the person making it to a 2015 study in the Journal of Sustainable Finance & Investment,

which examined about 2,200 pieces of research. It found that about 90% of those studies showed no negative relationship between concern for social factors and corporate financial performance. A large majority, in fact, showed positive findings that were stable over time. A 2016 study from the Journal of Applied Corporate Finance supplies additional support. The mutual fund researcher Morningstar filed a similar report last year.

Then, consider starting small, with a single request: Add a socially responsible fund that focuses on large U.S. companies. Socially conscious funds have crept into the mainstream over the past couple of decades, and funds that focus on big U.S. companies are a more mature area of socially conscious investing. (This makes sense; many investors prefer to invest in companies they know best, and companies in the United States disclose a decent amount about themselves.)

You don’t necessarily need to have a specific fund in mind. Many employers will have multiple outside parties helping run and shape their retirement plan, and those experts can help pick a fund.

But if you are inclined to make suggestions, Carole Laible, chief executive of the fund and investment manager Domini Impact Investments, suggested a few parameters. First, larger employers will often decline to consider funds that do not have three- or five-year track records. They may also want to see at least $150 million already in the fund, and they won’t want a big influx of money from their colleagues causing that employer’s plan to own more than 5% to 10% of the fund’s total shares.

All of this reluctance relates to that fiduciary duty requirement. Employers worry a fair bit about being sued for violating that duty if they make the wrong fund choices. It does happen: Jerome Schlichter has made a living helping employees sue everyone from Johns Hopkins

University to Ameriprise. So I asked him how he’d suggest employers avoid getting sued while still embracing ESG funds.

Schlichter suggested an augment-but-do-not-replace approach. Already have a bare-bones U.S. large-stock index fund in your plan? Carefully choose and then add a single ESG fund covering that same sector, instead of swapping it into the plan and ditching the index fund. That way, you have neither limited anyone’s existing choices nor taken away an index fund that is likely to have very low fees.

Marla Kreindler, a benefits specialist and Chicago-based partner with the law firm Morgan, Lewis & Bockius, offered another suggestion: Consider a brokerage window. This allows employees to, in effect, have their own investment account within their workplace retirement plan. There, they can choose from the whole universe of available mutual funds — social, anti-social or otherwise.