401(k) 'Windows' Reconsidered as Portals for ESG Investments

ERISA Advisory Council hearing highlighted brokerage windows and ESG funds

Stephen Miller, CEBS By Stephen Miller, CEBS July 15, 2021

The use of participant-directed "brokerage windows" within 401(k) and similar plans has so far been limited, but some plan sponsors are giving these investment platforms a second look to provide employees with access to environmental, social and governance (ESG)-focused mutual funds without adding more funds to the plan's investment lineup.

Although brokerage windows—also known as self-directed brokerage accounts (SDBAs)—let plan participants invest their account funds in stocks, bonds and other securities, plan sponsors often limit available investments to mutual funds, referring to the platform as a mutual fund window.

"ERISA's [the Employee Retirement Income Security Act's] overarching duties of prudence and loyalty still apply to a fiduciary's decision to make [brokerage windows] available, taking into account the nature and quality of the services provided by the arrangements," HR consultancy Mercer noted. However, ERISA doesn't require plan fiduciaries to evaluate the suitability of funds or other investments that participants select for themselves through SDBAs.

TSP to Open a Window

In June, the federal Thrift Savings Plan (TSP), which operates as a defined contribution plan for 6.3 million federal civilian employees and members of the armed services, said it would offer ESG funds in a new mutual fund window that will include over 5,000 funds. This feature will go live next summer.

Lisa Woll, CEO of US SIF, a trade group for the sustainable investment industry, said the group has been in talks with TSP about adding sustainable offerings for more than a decade, Barron's reported. Plan participants "can't get ESG options until they have that platform," she said.

In another sign that brokerage windows are receiving more attention, last month the Department of Labor's (DOL's) Advisory Council on Employee Welfare and Pension Benefit Plans, commonly called the ERISA Advisory Council, held hearings to discuss developments regarding SDBAs and whether further regulation of brokerage windows was warranted.

Limited Uptake

Investment firm Vanguard's How America Saves 2021 report disclosed that among the 1,700 employer-sponsored plans for which it provided record-keeping services last year, 20 percent offered a self-directed brokerage window, rising to 38 percent among plans with at least 5,000 participants.

However, in plans offering a self-directed brokerage feature, Vanguard reported, "only 1 percent of these participants used the feature in 2020. In these plans, about 2 percent of plan assets were invested in the self-directed brokerage feature."

Similarly, in asset-management firm Schroders' January 2021 survey of 230 retirement plan participants, 37 percent said they were offered ESG-related investment options by their employer, while 9 percent of participants who were aware of their plan's ESG options invested in those funds. In plans that did not currently offer an ESG option, 69 percent of respondents said they might increase their overall contribution rate if they had access to an ESG fund.

"Although participant uptake in brokerage windows is relatively low, it is an important tool for plan sponsors to use to respond to unique participant investing needs," Chantel Sheaks, vice president for retirement policy at the U.S. Chamber of Commerce, told the ERISA Advisory Council on June 24.

Plan participant requests, she noted, "include wanting more varied investment options beyond the core lineup or requesting a specific type of investment, such as Shariah investing, funds that do not include specific investments, or overall ESG investing."

Sheaks added that "including such investment as a core investment option may not make sense for the plan if few individuals are using it. Because of the work it takes to properly implement these, plan sponsors do not enter into these lightly."

Reviewing the Basics: ESG Investments

ESG or "socially responsible" mutual funds invest in companies that meet the fund managers' criteria for environmental stewardship, social justice and fund governance.

Some ESG funds exclude the stock of tobacco, fossil fuel, firearm and defense companies, and firms that are opposed to union organizing or that pay excessive executive compensation. They may favor companies that use renewable resources and are committed to gender equality, diversity and community engagement.

The Biden administration has taken various steps to support ESG investing in retirement accounts. In March, for instance, the DOL said it would not enforce a Trump administration rule that restricted 401(k) plan fiduciaries from considering nonfinancial matters, such as ESG factors, in choosing plan investments.

A criticism of ESG investment funds is that they tend to be more expensive than non-ESG funds. According to The Wall Street Journal, exchange-traded funds "that explicitly focus on socially responsible investments have 43 percent higher fees than widely popular standard" funds.

An October 2020 research paper from the Center for Retirement Research at Boston College concluded that ESG investments in public pension plans yielded lower returns than investments based on traditional financial risk and asset diversification factors.

More Choices, Greater Risks

While brokerage or mutual fund windows are a way to provide access to ESG investments, a common concern is that once a window is opened, participants could be lured into investing in high-risk, speculative non-ESG funds that place their money at great risk.

Alison Borland, executive vice president for wealth solutions and strategy at Alight Solutions, a retirement plan services firm, told the ERISA Advisory Council that "while brokerage windows can offer participants new investing opportunities, they aren't appropriate for everyone. Participants assume the full risk and responsibility for the investments they select, so they must be prepared to closely manage and monitor this portion of their plan."

She added that "if participants aren't experienced investors, don't have the time to do proper research, or don't seek professional advice, they may mismanage their 401(k) assets and make riskier decisions that the plan lineups are designed to help mitigate."

Kent Mason, a partner at law firm Davis & Harman in Washington, D.C., testified that the platforms can also reduce participants' risk. "Brokerage windows allow plans to avoid the very real risks of confusing or even paralyzing a large portion of their employees," which can occur when additional funds are placed in the core investment lineup, he noted, "while at the same time satisfying the desires of a smaller group of participants for more investment flexibility."

Kevin Mahoney, business development officer at FinDec, a provider of plan consultant and TBA services, testified that "providing participants with more choices about where to invest the money they save for retirement in their workplace benefit plan can be a positive."

He noted that "trade volume is on the rise within SDBAs, and average account balances are rising modestly. However, there are potential risks involved with self-directed accounts, particularly if participants do not understand investments or how markets tend to work in the long run."

Reducing Risk Exposure

To ease the way for plan sponsors to offer brokerage or mutual fund windows when it is appropriate for them to do so while reducing unnecessary liability risks for plan sponsors and financial risks to participants, Sheaks urged the DOL to:

  • Clarify the application to brokerage windows of ERISA Section 404(c), which requires plans to disclose certain information to plan participants about the plan's investment options.
  • Issue tip sheets to help plan sponsors understand what is involved from selecting, to monitoring to terminating a brokerage window option.
  • Provide model language and a checklist of suggested participant disclosures.

Frank Porter, president of the American Society of Pension Professionals & Actuaries, a national organization for retirement plan professionals, testified that "plans typically set a percentage limit on the portion of an individual's account that can be placed into a self-directed brokerage window."

Plan sponsor fiduciaries can add other restrictions to protect employees from excessive risk, noted Porter, also a relationship manager at Empower Retirement, a retirement plan record-keeping firm. For example, they may "limit investments to things such as no load/no transaction fee funds only."

[Small businesses can find offering a retirement plan to be daunting. SHRM is offering a program through Raymond James that may help. Visit www.shrm.org/401k to learn more.]

Related SHRM Articles:

More 401(k) Plans Want to Keep Retirees' Investments, SHRM Online, July 2021

State Auto-IRAs May Drive Some Small Businesses to Sponsor Their Own Plans, SHRM Online, July 2021

401(k) Plan Match Formulas, Automatic Features, Add Value for Participants, SHRM Online, July 2021



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