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DOL Opens The Door To SRI Investing In Retirement Plans

Sustainable, responsible, and impact (SRI) investing is a growing part of the investment landscape. Assets under management using SRI strategies now total $6.57 trillion, or $1 out of every $6 under professional management in the U.S., and these numbers are growing. 1 Between 2012 and 2014, SRI investing grew by more than 76%. 1 A recent survey indicates that the majority of millennials believe business can do more to address society’s challenges in the areas of climate change and resource scarcity. 2 This year Morningstar launched environmental, social, and governance (ESG) scores for global mutual and exchange-traded funds. 3 Despite the growing interest in SRI strategies, most retirement plans such as 401(k) plans were slow to incorporate ESG factors in the investment evaluation process. That may be about to change. Last fall the U.S. Department of Labor (DOL) published guidance that seems to open the door to greater use of SRI strategies in retirement plans. This guidance, in the form of an interpretive bulletin, steps back from prior DOL guidance that appeared to require plan fiduciaries to give economically targeted investments (ETIs) special scrutiny not required of other types of plan investments. While it is too early to tell whether the DOL bulletin will lead to increased adoption of SRI strategies by retirement plans, if you have clients or prospective retirement plan clients who have expressed an interest in SRI strategies, the new guidance provides an excellent vehicle for reexamining this issue. SRIs Defined A variety of terms in addition to “SRI” are used to describe an investment strategy that takes ESG factors into consideration to select investments that will have both competitive financial returns and a positive societal impact (e.g., socially responsible investing, sustainable investing). The DOL uses the term “economically targeted investments” (ETIs), which it defines as investments chosen because of “the economic benefits they create apart from their investment return to the employee benefit plan.” 4 Common types of investments include affordable housing, small business development, community services (child care, health care, education), job creation, expansion of existing businesses, and support of sustainable development initiatives. ETIs appear in a variety of forms including stocks, mutual funds, private equity, real estate, and fixed income. The “All Things Being Equal” Test The first formal position the DOL took on SRI investing, referred to by the DOL as ETIs, was in Interpretive Bulletin (IB) 94-1. In that bulletin, the DOL established the “all things being equal” test. This test had three prongs. A plan fiduciary can never subordinate the interests of plan participants and beneficiaries to a social purpose. The ETI must have an expected rate of return commensurate to rates of return of alternate investments “with similar risks available to the plan.” The ETI must otherwise be an appropriate investment considering the diversification of plan investments and the plan’s investment policy. As long as plan interests were not subordinated and the ETI could be expected to return a comparable rate of return as investments with similar risks, a plan fiduciary could offer ETI as an investment option. In effect, plan fiduciaries could use ESG factors to break a tie with an equivalent non-SRI option. Special Scrutiny Requirement Added in 2008 IB 94-1 remained the DOL’s principal guidance on the topic until it was replaced in 2008 by Interpretive Bulletin 2008-1. The 2008 pronouncement put SRI strategies in a much less favorable light as compared to the 1994 guidance. In the 2008 bulletin, the DOL said that consideration of non-economic, ESG factors Should be rare, and When an ETI is considered, the decision to invest should be documented in a manner that demonstrates compliance with ERISA’s rigorous standards. The 2008 bulletin seemed to require plan fiduciaries to give a level of attention and circumspection to SRIs not required for other plan investments. DOL Restores & Enhances the “All Things Being Equal” Test Recently, the DOL expressed its view that the 2008 bulletin was unduly discouraging plan fiduciaries from investing in ETIs or considering ESG factors, even when the investments were economically equivalent.5 To address these concerns, the DOL withdrew the 2008 bulletin and replaced it with IB 2015-01, guidance more aligned with the position it had communicated in 1994. In its Fact Sheet released with the 2015 bulletin, the DOL said that the “IB also acknowledges that in some cases ESG factors may have a direct relationship to the economic and financial value of the plan’s investment.” 5 The DOL went on to say that, “in such instances, the ESG issues are not merely collateral considerations or tie-breakers, but rather are proper components of the fiduciary’s primary analysis of the economic merits of competing investment choices.” 5 The effect of the DOL’s 2015 bulletin is significant. The three-prong test of IB 94-1 is restored. Plan fiduciaries do not have a “higher level” obligation to scrutinize and document ETIs than they do for other plan investments. ESG factors can be taken into account in determining the economic benefit of investments and to find superior investments. Challenges & Opportunities If you have retirement plan clients or prospective clients who are interested in SRI strategies, IB 2015-01 provides an excellent vehicle for discussing whether SRI strategies are a good fit for their retirement plan’s investment portfolio. Following are some possible discussion points to include in your SRI discussions. Discuss whether your client wants to incorporate ESG factors in their investment evaluation process . Do members of the plan’s investment committee believe that ESG factors will materially impact the financial performance of the plan’s investments? Are there demographic and diversity factors at play that will affect the decision to provide ESG-driven funds such as a high concentration of Millennials? Do members of the committee need additional education regarding SRI investing? Evaluate how an SRI strategy would impact the existing fund lineup . How many investment options are currently provided to participants? Where in the fund lineup would it make sense to add an SRI strategy? Consider how to integrate SRI beliefs and expectations into the existing investment policy statement (IPS) and investment due diligence process . Does the IPS need to be adjusted to incorporate ESG considerations? Will there need to be any changes in the process for selecting and monitoring the plan’s investment menu? Does the documentation retained by the investment committee need to be modified or expanded? These basic inquiries will be a good starting point for discussing SRI strategies with plan sponsors. As with all investment decisions, you play a critical role in helping your plan sponsor clients define and pursue investment objectives that are right for their plans. Clients that elect to adopt an SRI strategy will need your support to Define their investment objectives Develop or amend the IPS that sets out clear rules and metrics for evaluating investment return and risk equivalencies Identify and evaluate investment opportunities Review and evaluate SRI fund prospectuses Document the SRI decision-making process, as they do with other plan investments Educate plan participants about SRIs Footnotes US SIF Foundation, Report on US Sustainable, Responsible, and Impact Investing Trends 2014 Deloitte, The Deloitte Millennial Survey , January 2014 Morningstar, Inc. Press Release, “Morningstar Introduces Industry’s First Sustainability Rating for 20,000 Funds Globally, Giving Investors New Way to Evaluate Investments Based on Environmental, Social, and Governance (ESG) Factors,” March 1, 2016 Department of Labor, Interpretive Bulletin 2015-01, October 26, 2015 Department of Labor, Fact Sheet: “Economically Targeted Investments (ETIs) and Investment Strategies that Consider Environmental, Social and Governance (ESG) Factors,” October 22, 2015 FOR INVESTMENT PROFESSIONAL, BROKER-DEALER AND INSTITUTIONAL USE ONLY. NOT FOR USE BY OR DISTRIBUTION TO THE GENERAL PUBLIC. This material is for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice. Information is obtained from sources deemed reliable, but there is no representation or warranty as to its accuracy, completeness or reliability. All information is current as of the date of this material and is subject to change without notice. Neuberger Berman does not accept any responsibility to update any opinions or other information contained in this document. Any views or opinions expressed may not reflect those of the firm or the firm as a whole. This material is informational and educational in nature, is not individualized and is not intended to serve as the primary or sole basis for any investment or tax-planning decision. Investing entails risks, including possible loss of principal. The material includes copyrighted information of Integrated Retirement. ©2016 Integrated Retirement. Published by permission. All rights reserved. Neuberger Berman LLC is a registered Investment Advisor and Broker Dealer. Member FINRA/SIPC. The “Neuberger Berman” name and logo are registered service marks of Neuberger Berman Group LLC. All rights reserved. © 2009-2016 Neuberger Berman LLC. | All rights reserved) from the feed, and any images/charts as they appear on the original blog article

Is It Ever A Bad Time To Invest?

When the markets seem scary, it’s tempting to wait for a “better” time to invest. History suggests this may be a mistake. Many investors feel nervous about making a commitment to equities, particularly following robust periods of market performance. There are always economic clouds on the horizon, and no one wants to envision their investments taking an immediate loss. But trying to “time the market” by waiting for a more opportune time to invest may be a mistake, as time horizon has often been a significant factor in long-term market results. We would all time the market if we could do it successfully. Who wouldn’t want to avoid major market declines or fully participate in a bull market? The problem is that market timing requires one to make decisions that even professionals find difficult, if not impossible. This is not to say that considering the overall direction of the markets and making tactical tilts aren’t without merit. Trying to time one’s overall exposure to the equity market, however, brings with it a new set of risks, and may ultimately derail an investor’s long-term goals and objectives. The Pitfalls of Timing Individual investors are notoriously bad at picking the right times to invest. Fund flows show that investors tend to move in and out of the market at precisely the wrong time – in essence, buying high and selling low. In 2008 and 2009, for example, during the depths of the bear market, investors pulled significant assets out of equity funds. Several years later, they moved back into equity funds just as many equity indexes were approaching or had surpassed old highs (see Figure 1). Figure 1: Market Timing Travails Source: Strategic Insight Simfund MF, FactSet. Indexes are unmanaged and are not available for direct investment. Investing entails risks, including possible loss of principal. Past performance is no guarantee of future results. In fact, the patterns of overall equity market returns are one of the reasons that market timing is so difficult. Market increases have often come in spurts, and missing some of the market’s best days could have a significant impact on returns, as those days have historically accounted for a surprising portion of the market’s overall annual returns (see Figure 2). Figure 2: Impact of Missing Equity Market’s Best Days S&P 500 10 Years Ending October 21, 2015 Source: FactSet. Indexes are unmanaged and are not available for direct investment. Investing entails risks, including possible loss of principal. Past performance is no guarantee of future results. Over Time, Stocks Have Tended To Go Up Over extended periods of time, the U.S. stock market has tended to rise in value. Consider Figure 3, which shows that the S&P 500 has risen in 75% of all one-year time periods since reliable market data began (in 1926). Over longer periods, the percentage of positive outcomes has also increased as well – for example, there has been no 15- or 20-year period in the S&P 500’s history in which the index has registered a negative return. Figure 4 shows the S&P 500’s performance over rolling 10-year periods (that is, the 10-year periods ending in 1935, 1936, 1937 and so on). In only two instances – ending in the depths of the Great Depression and in the midst of the global financial crisis – did the S&P 500 produce negative returns after a 10-year holding period. We believe this underscores the importance of maintaining a long-term perspective. Figure 3: The Percentage of Positive S&P 500 Outcomes Has Varied by Holding Period Source: FactSet. Indexes are unmanaged and are not available for direct investment. Investing entails risks, including possible loss of principal. Past performance is no guarantee of future results. Figure 4: Benefits of Long-Term Investing S&P 500 10-Year Rolling Returns Source: FactSet. Data as of October 31, 2015. Indexes are unmanaged and are not available for direct investment. Investing entails risks, including possible loss of principal. Past performance is no guarantee of future results. Managing Risk Through Diversification Of course, the case for any given asset class only goes so far. Maintaining diversification is another way to help mitigate the downside risk of an overall portfolio. Investors have often relied on a mix of stocks and investment-grade bonds for this reason. In the current low-yield environment, however, we favor diversification across a broader asset allocation framework that reaches beyond traditional equities and fixed-income to enhance diversification against broad market risk. Investors today also have access to a broader array of investment options that can provide diversification benefits. For example, once the province of institutions and wealthy individuals, alternative investment strategies are now increasingly available in vehicles without investor qualification restrictions. So-called “liquid alternative” funds are retail mutual funds that pursue alternative investment strategies. Adding alternatives strategies to a portfolio of traditional equity and bond investments can help lower correlations to equity and fixed-income markets. Given the significantly expanded range of alternative strategies available today to a broad audience, adding the potential diversification benefits of non-traditional approaches has become a simpler exercise. Climbing The Wall Of Worry Over time, the stock market has managed to navigate periods of economic crisis and geopolitical uncertainty and has overcome significant market pullbacks. Although the global economy continues to expand at a moderate pace, helped by the stimulative efforts of central banks, the proverbial wall of worry stands high today. The Federal Reserve’s potential tightening cycle, China’s slowing growth trajectory, weak commodity markets and elevated valuations are just a handful of concerns that have investors pondering a move to the sidelines. The angst investors feel in the current environment is understandable, and behavioral tendencies can be difficult to resist. Working with a financial advisor can provide investors with a long-term perspective and help them make decisions based on goals, objectives and risk tolerance rather than emotion. This material is provided for informational purposes only. Nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. The views expressed herein are generally those of Neuberger Berman’s Investment Strategy Group (ISG), which analyzes market and economic indicators to develop asset allocation strategies. ISG consists of a team of investment professionals who consult regularly with portfolio managers and investment officers across the firm. Indexes are unmanaged and are not available for direct investment. Investing entails risks, including possible loss of principal. Past performance is no guarantee of future results. Any views or opinions expressed may not reflect those of the firm as a whole. Third-party economic or market estimates discussed herein may or may not be realized and no opinion or representation is being given regarding such estimates. Certain products and services may not be available in all jurisdictions or to all client types. Indexes are unmanaged and are not available for direct investment. Unless otherwise indicated, returns shown reflect reinvestment of any dividends and distributions. Neuberger Berman LLC is a Registered Investment Advisor and Broker-Dealer. Member FINRA/SIPC. The “Neuberger Berman” name and logo are registered service marks of Neuberger Berman Group LLC.