The behavioral side of ESG investing in retirement plans

ESG are the three letters that are nowadays tough to avoid in any conversation about retirement saving. Some even call it the next big thing after target date funds. ESG stands for using Environmental, Social and Governance factors to evaluate potential investments of pension funds. Looking at it from an alternative perspective, not just purely financial, brings to light some interesting new arguments in favor of ESG, that might just bring to retirement saving something that has long been missing. What am I getting at?

One of the main challenges of retirement saving is that you have to pay contributions for 40 years and in this long time period you get nothing in return, except the promise of financial security in retirement, which doesn’t really make most people sleep any better at night. Buying a new car or a house with credit gives you just the opposite, for a monthly installment you get to drive your dream car every day, or you and your family get to enjoy your beautiful new country home, giving you lots of joy and other positive emotional rewards every single day. Retirement saving is intangible and if you are not like me and get excited over looking at your online savings account, doing the right thing and saving for retirement doesn’t really give you much positive emotional rewards while you are doing it and you have to wait a long time for the reward. Even when you finally get it, whether it be a monthly annuity, or some other form of draw down, it is far from something exciting.

Well ESG might just help with that as incorporating ESG principles in the investment strategy of your retirement plan might give you some benefits of retirement saving now, as you will literally help save the environment, get cars of the streets, shut down those pesky coal plants and save the wildlife all in one go (not being cynical at all here). The biggest side effect of ESG investing might be just that –  giving savers some tangible rewards now and with that helping them to overcome intangibility and also the other bias working against retirement saving, which is present bias. It refers to our tendency to give stronger weight to payoffs that are closer to the present. Most of us are impatient and would like immediate gratification if possible and that has a big influence on our daily decision making and for sure does not help retirement saving. We will always rather spend our paycheck on new shoes, purses or other consumer goods that promise us instant satisfaction, than save it for our retirement. That’s just how we are wired and you can read more about the present bias and financial behavior in an article by Jing Jian Xiao and Nilton Porto [1].

Thinking about it I really believe ESG might help with giving pension plan members some instant satisfaction and every month when they will make their contributions to the plan they might just feel some warmth in their hearts about doing something good in this world and it’s all thanks to their retirement plan. And when did you last feel some warmth in your heart when thinking of your retirement plan? Probably never. So ESG has potential to capture people’s hearts and minds, as the saying goes, but as always, the devil is in the details. Key to this will be communication with members and folks at UK`s Nest Insight are already on to this and have ongoing studies focusing on how ESG investing can be used as a motivator of pension engagement. Their latest research programme looked at whether communicating with pension plan members about the positive impact of their investments could make them more likely to engage more with their retirement plan. So what did they find out?

As expected ESG is no silver bullet and their research suggests communications around ESG issues do not engage everyone in the same way and for some the additional information is too much and reduces potential engagement. Still they found out that overall, a responsible investment message had broader appeal than a more traditional investment message. Interestingly “ESG” does not seem to be the term that engages pension plan members very effectively and they suggest the phrase ‘responsible investment’ to work better by conveying prudence and safety and also at the same time communicating a focus on investing more sustainably for the future. Framing the messages related to ESG or responsible investment will be key and they provide some good hints on framing the messages in the right way, for example framing the messages about investments as proactively doing good instead of framing them as avoiding the bad. Their initial findings suggest ESG investments have potential to increase engagement with pension plan members, if done the right way and to reach members who would otherwise not be engaged at all [2]. 

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We also need to keep in mind that the generation of millennials is more and more represented in retirement plans as baby boomers are entering retirement so finding topics to engage millennials in connection with retirement saving will be key for the future and what better topic to connect millennials and retirement saving than ESG. Millennials are already known for preferring to invest in alignment with their personal values. Survey of high net worth investors from Morgan Stanley Institute for Sustainable Investing found that 95% of millennials were interested in sustainable investing [3] and EY`s research suggests millennial investors are nearly twice as likely to invest in companies or funds that target specific social or environmental outcomes [4]. So with millennials soon becoming the most important generation for retirement plans they need to adapt to this and start addressing the issues that matter to millennials, if they will want to win them over, otherwise they may save for retirement somewhere else.  

Clearly the topic of how ESG investing should be communicated to members of pension plans needs to be more researched and foremost tested in real life. Luckily Nest Insight already plans to go further with their research in this field and I really look forward to more of their results that are scheduled to be published in 2021. The new generation of savers will look not only at yields and fees, but will expect something more of their retirement plan and it`s investments – making a positive impact now and the retirement industry needs to adapt to this for the good of all of us.

References: 

[1]. Jing Jian Xiao and Nilton Porto, Present bias and financial behavior, Financial Plannin Review, Volume 2, Issue 2, 2019. Retrieved from https://onlinelibrary.wiley.com/doi/full/10.1002/cfp2.1048  

[2] Jo Phillips and Will Sandbrook, Nest Insight, London, 2020. Retrieved from https://www.nestinsight.org.uk/wp-content/uploads/2020/11/Responsible-investment-as-a-motivator-of-pension-engagement.pdf

[3] Sustainable Signals: Individual Investor Interest Driven by Impact, Conviction and Choice. Morgan Stanley Institute for Sustainable Investing, 2019. Retrieved from: https://www.morganstanley.com/pub/content/dam/msdotcom/infographics/sustainable-investing/Sustainable_Signals_Individual_Investor_White_Paper_Final.pdf 

[4] Why sustainable investing matters, EY Americas, 2018. Retrieved from: https://go.ey.com/2DGmfWr

Published by Ziga Vizintin

Nudging people to save for retirement one nudge at a time.

One thought on “The behavioral side of ESG investing in retirement plans

  1. Hi Ziga, this was a really interesting post – I’m in the exact demographic that you describe, in my mid-30s and concerned about climate change and the like. Apart from research and think-tanks, have you seen any companies that focus on this kind of behavioural finance? I’d love to learn more!

    Like

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