Morningstar - Q1 2023 - 14

Dispatches
Fortunately, there is positive movement on the
federal legislation front in the U.S. in addressing
these issues. Pooled-employer plans were
introduced in 2022, providing an additional way
for small employers to offer a workplace
plan. Further, legislation passed at the end of
2022 introduced a requirement for new plans to
auto-enroll their employees starting in 2025
and allows for service providers to automatically
port over workers' savings to their new
accounts when changing jobs.
How Much Choice Is Too Much?
While choice of investment options is good,
especially for experienced investors, too
much choice is counterproductive, particularly
for inexperienced investors. Some countries
are better than others at optimizing plan
choices so that participants are more likely to
select a high-quality, low-fee investment
or be defaulted into such an option.
For those with access to a U.S. workplace plan,
the fiduciary duty that plan sponsors must
uphold when selecting investment options sets
a high bar. With target-date funds as the
common default for plans with auto-enrollment,
workers are provided with an asset allocation
calibrated based on their years to retirement.
Most plans offer a reasonable number of
alternatives, providing flexibility for those looking
to customize their investment strategy
but without so many overlapping options that
it creates confusion.
Reducing Complexity as a Maxim
A common challenge we observed across
heterogeneous retirement frameworks is
complexity. They generally operate within complex
rules and offer investment options that may
not be intuitive to inexperienced investors.
Together, these factors make it challenging to
ascertain how best to both accumulate,
and then decumulate, retirement savings.
Getting unconflicted fiduciary advice to workers
and retirees cost-effectively is a resulting
challenge that still eludes most countries.
Overall, the hallmarks of the best-placed
workplace plans are government-mandated
contributions; savings incentives, such
14
Morningstar Q1 2023
as tax breaks or government contributions and
employer-contribution-matching programs;
and transparent oversight or benchmarking of
funds' performance and costs. K
Lia Mitchell is a senior analyst, policy research,
at Morningstar.
material to the plan's investments. That
has not changed and is part of the so-called
duty of prudence.
New ESG Rule
for Retirement Plans
Plans should treat
sustainability as any
other relevant factor.
Jon Hale
SUSTAINABILITY MATTERS
What has changed is that the new rule makes
clear that these factors may include climate
change and other ESG issues. That means plan
administrators may consider climate
change and other ESG factors when selecting
managers for defined-benefit plans or
selecting funds for defined-contribution plan
lineups. That also means that those making
direct investment decisions for a plan,
like fund managers, may consider climate and
ESG in their investment process.
The Trump-era rule being replaced was opaque
about whether it was prudent for a fiduciary
to consider climate change or other ESG issues.
It said " nonpecuniary " factors could not be
considered by a fiduciary and strongly suggested
that ESG issues were hardly ever pecuniary.
Climate change was never so much as mentioned
in the proposed or final rule.
The U.S. Department of Labor finalized a rule
in late November that will remove barriers,
real and perceived, to environmental, social, and
governance investing in retirement plans
governed under the Employee Retirement Income
Security Act of 1974, or Erisa.
Called " Prudence and Loyalty in Selecting Plan
Investments and Exercising Shareholder
Rights, " the new rule replaces two hastily drawn
rules rushed to the finish line at the end of the
Trump administration. Those rules were widely
interpreted as discouraging retirement plan
fiduciaries from considering ESG factors and from
exercising shareholder rights.
Here are four key takeaways about the new rule:
1 Fiduciary Duty Includes Consideration of
Climate Change and Other ESG Issues
Under Erisa, a retirement plan fiduciary must
base decisions on factors that the
fiduciary reasonably determines are financially
The current Labor Department concluded
that the previous rule was deterring retirement
plan fiduciaries from acting prudently on
behalf of beneficiaries in taking steps that many
other marketplace investors have been
taking to enhance the performance of their
investments-namely, taking climate change
and other ESG factors into consideration.
2 QDIAs Also Get the Go-Ahead to Consider
Climate Change and Other ESG Factors
The Trump-era rule essentially banned the
consideration of supposed nonpecuniary issues
like climate change and other ESG factors in
decisions related to qualified default investment
alternatives, or QDIAs, in defined-contribution
plans. QDIAs are the default investments
used when an employee contributes money to
the plan but hasn't selected an investment.
Under the new rule, the same standards apply
to QDIAs as to investments generally.
This is important because QDIAs attract the
lion's share of defined-contribution plan
contributions, mainly through the use of targetdate
funds. Plan administrators may now
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Morningstar - Q1 2023

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