ESG Fund Allocations Among New, Do-it-Yourself Defined Contribution Plan Participants

Abstract

Investment strategies focused on Environmental, Social, and Governance (ESG) issues have been receiving increased interest among defined contribution (DC) plan sponsors, consultants, and regulators. This research explores the allocation decisions of 9,324 newly enrolled DC participants who are self-directing their accounts in a DC plan that offers at least one ESG fund. Overall interest in ESG strategies among these participants is relatively weak, with only 8.9% of participants having any allocation to an ESG fund and average allocations to ESG strategies of only 18.7% among those holding any ESG funds. While there are some clear demographic preferences for ESG funds (e.g., among younger participants with higher incomes), ESG allocations appear to be primarily a function of weak preferences, driven by naïve diversification. There is a notable plan interest effect, whereby ESG allocations are significantly higher in plans where general ESG usage is higher. Participants who self-direct their portfolios have significantly lower expected returns than those using professionally managed investment options, such as target-date funds, which is an important consideration for plan sponsors when adding ESG funds to the core menu to the extent they entice participants to self-direct their accounts. Overall, this research paints a mixed picture about the actual participant interest, and drivers of demand, for ESG funds in DC plans and suggests that plan sponsors should take a thoughtful approach when considering adding ESG funds to an existing core menu.

Keywords: ESG; defined contribution; 401(k) plans