There once was a time when most American workers had a defined benefit pension plan. Those quaint and increasingly-rare arrangements provided the employee and his or her family with a future benefit based on years of service, final salary, etc. Today, it is more likely that you are responsible for your own retirement plan. Through a 401k, IRA or other tax-deferred structure, each investor must save and invest sufficient sums to last them into their twilight years.
Whether or not you are covered by a “pension plan”, someone is charged with managing risk. Risk is more than market volatility. It is company specific, as well. And while diversification is an important part of mitigating company-specific risk, large investors are actively seeking further risk reductions. “Could carbon legislation be one of those risks?” they ask. “How could a company’s reputation and brand be damaged from environmental or social missteps?” Large pension managers, in many cases, are trying to mitigate risks by building sustainable and responsible portfolios.
Why are pension managers are worthy of our attention, and possible imitation? They are often on the cutting edge of investment techniques, and they are held to a very high and public standard. They are performance driven, and risk aware. When they make mistakes, the plan sponsor may have to add more money to the plan, which directly impacts their reported earnings. Ouch! So, their attention to sustainable investing is of interest to individuals who must manage their own retirement assets.
Thinking like a pension manager, how might an individual implement SRI in their retirement assets? First, let’s visualize (in pie chart fashion) how a pension is managed. At the top, the Chief Investment Officer works with his or her team to design a broad asset mix that meets the risk and return needs of the plan. Investment advisors are hired to manage particular segments of that allocation (slices of the pie). In the course of managing the plans assets, advisors are often dismissed, and new ones hired, in an attempt to improve results. In implementing an SRI approach, sustainable investment vehicles replace outgoing managers.
As individuals, let’s say that we have decided to reduce risks in our plan from ESG issues (environmental, social and governance.) This is a good time to adjust our asset allocation plan in light of any newly-discovered issues or if our allocation has drifted from our initial plan. As we fill out the slices of this pie, we will want vehicles that focus on companies that are best-in-class from any ESG analysis. A company’s membership in one of the MSCI, Dow Jones of other SRI Index is some confirmation of best-in-class status. This is an important second step, but these aren’t our only criteria. As pension managers, we are concerned about risk, in its many forms, and return.
Remember that we don’t want to add volatility, so we need make certain the portfolio remains sufficiently diversified by industry — perhaps even resembling the old benchmark’s industry exposures. Fortunately, many SRI indexes are constructed in this fashion, which means that more and more investment vehicles will be constructed to fit these criteria. Our challenge is to select the best investment managers or vehicles to meet our needs. Fortunately, there are many from which to choose. Morningstar is a good place to start if you are interested in mutual funds or ETFs. If your retirement assets are confined to a company 401k plan, talk to HR about adding SRI options to the plan.