Sustainable Investing for Retirement Plans€¦ · workers save and invest for retirement. As a plan sponsor, ... mutual funds over a seven-year ... good ESG practices were better

Defined contribution plans have become the primary mechanism by which American workers save and invest for retirement. As a plan sponsor, you are responsible for selecting the investments offered within your defined contribution plan. Morgan Stanley believes that you can offer a highly competitive retirement plan to your participants by incorporating sustainable investment strategies — offering funds that pursue a positive social and environmental impact without compromising performance.

Table of conTenTs

3 The Evolution of Sustainable Investing

5 The Opportunity for Retirement Plans

6 Sustainable Investing Approaches

8 Steps to Incorporating Sustainable Investment Options

9 Conclusion

Sustainable Investing for Retirement Plans

sustainable investing for retirement plans

2 Morgan Stanley | 2016

$1 in $6More than $1 in $6 under professional

management in the U.S. uses sustainable investing approaches.1

Millennials are 2X more likely than other individual investors to invest in

companies or funds that target specific social or environmental outcomes.3

sustainable Investing by the numbers

71% of active individual investors are interested in sustainable investing.2

71%

The sustainable investing field is rapidly growing. Investors can now choose among a range of approaches — from screening out certain industries based on values to factoring in environmental, social and governance (ESG) principles as well as targeting specific social and environmental benefits.

Regulatory, corporate sustainability and demographic changes all point to the continued rapid growth of sustainable investing approaches. Morgan Stanley is at the forefront of sustainable investing and believes defined contribution

plans are well-positioned to benefit by capturing investor demand, while maintaining a focus on long-term value.

This brief provides background intelligence and actionable insights for plan sponsors seeking to incorporate sustainable investments into their defined contribution plans. Our goal is to help employers add sustainable investment options to their retirement plans that reflect the company’s purpose and the attitudes of employees without sacrificing their financial interests.

TerminologyWhile specific terms and acronyms — “socially responsible investing,” “value-based investing,” “impact investing,” “SRI,”

“ESG” —can create confusion, investors are increasingly aware of and concerned about the positive and negative external impacts of their investment decisions.

What is sustainable investing?The practice of making investments in companies or funds that aim to achieve market-rate financial returns alongside positive social and / or environmental impact.

What are esG factors?Environmental, social and governance factors refer to a range of nonfinancial performance areas that arise due to a company’s operations, product or supply chain along with interactions with customers, communities and employees, which may have financially material implications on business performance.


3Morgan Stanley | 2016

The Evolution of Sustainable InvestingSustainable investing is much more than the latest buzzword among investors; it is a way of thinking about the long-term value of an investment by considering social and environmental outcomes, as well as financial returns. The field is entering the mainstream, with a strong track record in recent years and significant growth projected. As of 2014, more than $1 out of every $6 under professional management in the U.S. utilized sustainable investment criteria. The total amount of these assets expanded to $6.57 trillion, a two-year increase of 76 percent between 2012 and 2014.4

Market Trends Driving sustainable InvestingSeveral powerful societal and market trends are contributing to this boom in sustainable investing. In fact, a new generation is changing the way Americans think about economic value. Millennials (born 1981 to 1997) now make up one-third of the U.S. workforce, and in 2015 surpassed Generation X (born 1965 to 1980) to become the largest age group.5 It is well documented that Millennials believe corporations have a responsibility to improve society in addition to creating shareholder value. This is translating into new purchasing and employment behaviors, with Millennials nearly twice as likely as other age groups to purchase from brands they consider to be sustainable and nearly three times more likely to seek employment at companies based on their social and / or environmental performance.6 Furthermore, Millennial investors are nearly twice as likely as other investors to invest in companies or funds that target specific social or environmental outcomes.7 Already, Millennials outnumber Baby Boomers8 (born 1946 to 1964), and an estimated $30 trillion in wealth will transfer to younger generations in the next 30 to 40 years.9 This has the potential to change significantly both the sustainable investing trajectory and the investment landscape in general.

Beyond the influence of a new generation of workers, corporations are evolving and responding to consumer

interest in corporate sustainability. In an increasingly connected world, many companies are looking to create positive value for all stakeholders — including customers, community members, employees, shareholders and suppliers. Often this approach is captured in either a mission statement or corporate values with a focus beyond simply making profit for shareholders. Organizations seeking to outperform competitors in terms of innovation, productivity, customer loyalty and profitability need to attract and retain the best talent. Offering sustainable investment options in their retirement plan is one way companies can demonstrate to employees, and a

wider stakeholder audience, that they act on their values and take corporate responsibility seriously.

sector Trends Macroeconomic trends in sectors such as energy, health, agriculture and education also point to an ever-growing market for sustainable investing. The World Business Council for Sustainable Development estimates the value of new opportunities in these sectors at $10 trillion, or 4.5 percent of GDP, by 2050.10 In just the next 15 years, it’s expected that global demand for food will increase by 35 percent,11 water by 40 percent12 and energy by 50 percent.13

Total Volume of sustainable Investments nearly Doubled from 2012 to 2014

Source: U.S. SIF, Report on Sustainable and Responsible Investing Trends in the United States (2014)

1995 1997 1999 2001 2003 2005 2007 2010 2012 2014

$ Tr

illio

ns (U

SD)

7

6

5

4

3

2

1

0



strong Performance Sustainable investing is not altruistic. Although some investors are quick to question the practice over worries that limiting the investable universe could result in trade-offs for financial performance, the reality is different. A 2015 study by the Morgan Stanley Institute for Sustainable Investing examined the performance of 10,000 mutual funds over a seven-year period. In 64 percent of cases, they found sustainable equity mutual funds had equal or higher median returns and equal or lower volatility than traditional funds.14

Increasingly, investors are showing interest in sustainable investing for its performance potential as well as its societal and risk mitigation benefits. A 2015 Morgan Stanley survey of 1,000 active individual investors found that nearly half believed sustainable companies were more innovative, 30 percent believed sustainable companies attract better talent, and 72 percent believed companies with good ESG practices were better long- term investments. Overall, 71 percent of survey participants were interested in sustainable investing, with deeper engagement from female investors (76% interested) and Millennial investors (84% interested).15

64% of the time, sustainable equity mutual funds showed equal or higher median returns than traditional funds.

64%

sustainable Investing opportunities could amount to $10 Trillion, or 4.5%, of World GDP in 2050

Health & Education$3.5 Trillion

Agriculture & Food$1.88 Trillion

Power$3 Trillion

Metals$700Bn

Water$300Bn

Forestry$300Bn

Source: World Business Council for Sustainable Development, Vision 2050: The New Agenda for Business (2010).



The Opportunity for Retirement PlansRetirement plans are prime territory for sustainable investing strategies. Both subjects support a focus on the long term. Many social and environmental outcomes associated with sustainable investing compound over time. Natural resource health and improving financial access, for example, can’t be measured from quarter to quarter. By focusing on a longer time horizon, retirement investors can potentially reap competitive market-rate returns, while supporting positive social and environmental impact.

Regulatory changesRecent policy changes have made it significantly easier for plan sponsors to offer sustainable investing solutions in their defined contribution plans. In late 2015, the U.S. Department of Labor (DOL) issued guidance that eased the fiduciary burden on sustainable retirement investing and recognized the potential financial value of such investment approaches. In announcing the guidance, Secretary of Labor Thomas Perez asserted that “Investing in the best interests of a retirement plan and in the growth of a community can go hand in hand.”16

Before the new guidance, it had been unclear whether sustainable investing — which the DOL calls economically targeted investing (ETI) — was compatible with the fiduciary duty of managing plans governed by the Employee Retirement Income Security Act of 1974 (ERISA). Now, plan sponsors are no longer required to document how non-economic factors can contribute to the value of a plan’s investment selections (see box). Not only do the DOL’s new guidelines acknowledge that social and environmental factors can be used as tie-breakers for otherwise equal investment opportunities, they also state that ETI investments and ESG factors can be included in baseline financial analysis when appropriate.17

a Mission-Driven corporate sectorPlan sponsors can choose from a growing range of sustainable funds that reflect the purpose of their company or organization and the values of the employees (see Sustainable Investing Approaches on

page 6). For example, a clean technology company may want to offer a fund that screens out fossil fuel risks, while an educational institution may wish to offer funds that support community economic development. As the field grows, more options are emerging to meet a wide range of specific investor objectives while pursuing competitive returns.

shifting DemographicsAs the share of Millennials among employer plan participants grows, it will become more important for plan sponsors to consider offering sustainable investment options within their retirement plans. Already, Millennials are saving for retirement at younger ages, and at higher rates, than any

generation before them. A 2014 survey from Transamerica Center for Retirement Studies found that 70 percent of working Millennials are already saving for retirement and began doing so at a median age of 22.18

The sustainable investing market continues to evolve — looking forward, expect to see sustainable investing integrated into target date funds and other innovative structures designed for defined contribution plans as a direct response to this opportunity. Understanding the full spectrum of sustainable investing approaches currently available will help plan sponsors identify which are best aligned with the worldview of their organization and the plan’s participants.

Previous Guidance — 2008• Fiduciary consideration of noneconomic factors in selecting plan investments

should be rare and fiduciaries may never subordinate the economic interests of the plan to unrelated objectives.

• When considered, noneconomic factors needed to be “documented in a manner that demonstrates compliance with ERISA’s rigorous fiduciary standards.”

Source: U.S. Department of Labor, RIN 1210-AB29 Interpretive Bulletin Relating to Investing in Economically Targeted Investments (2008).

revised Guidance — 2015• ESG issues may have a direct relationship to the economic value of the

plan’s investment.

• These factors may not merely be collateral considerations or tie-breakers, but part of a fiduciary’s primary analysis.

• Consideration of economically targeted investments or ESG criteria does not presumptively need additional documentation or evaluation beyond that required by fiduciary standards applicable to plans generally.

Source: U.S. Department of Labor, “New Guidance on Economically Targeted Investments in Retirement Plans from U.S. Labor Department” (October 2015).

U.s. Department of labor eRIsa Guidance on sustainable Investing



Sustainable Investing Approaches Selecting the right sustainable investing approach requires careful evaluation of investor objectives, values and capacity for risk. Morgan Stanley has identified, and uses, a spectrum of approaches ranging from minimizing negative impacts (values alignment), using ESG analysis to identify investment opportunities and risks (ESG integration — see page 7 for examples of ESG factors) to targeting specific social and environmental themes (thematic exposure) that can be flexible to fit a variety of financial and sustainability goals. Every sustainable investing product offered by Morgan Stanley fits into at least one of these categories. Morgan Stanley calls this range of approaches Investing with Impact and the framework, below, provides a useful reference point for plan sponsors seeking the appropriate approach(es) for their organization.

sustainable Investing framework

IMPacT PRIoRITIes

chaRacTeRIsTIcs

InVesTMenTexaMPles

ValUes alIGnMenT

enVIRonMenTal, socIal anD GoVeRnance (esG) InTeGRaTIon

TheMaTIc exPosURe

• Managing exposures by intentionally avoiding investments based on specific criteria

• Proactively considering ESG criteria alongside financial analysis to identify opportunities and risks during investment process

• Focusing on themes and sectors dedicated to solving sustainability- related domestic and global challenges

• Differentiated by restriction criteria and degree of shareholder advocacy

• Not proactively seeking environmental and social impact

• Differentiated by ESG integration process and degree of shareholder advocacy

• May also include screens

• Differentiated by macro-analysis, sustainability research and sector focus

• Mutual fund that excludes companies from buy universe (e.g., tobacco, firearms, coal mining companies)

• Separately Managed Account (SMA) incorporating analysis of ESG performance into stock selection process

• Exchange-traded fund (ETF) tracking index of renewable energy companies

Source: Morgan Stanley, Investing with Impact (2016)



This range of strategies is well aligned with the long-term outlook of retirement plans. Research demonstrating a positive relationship between stock performance, operational performance and reduced cost of capital19 may support the inclusion of funds that practice ESG integration. Likewise, a mission-driven company or organization may choose a thematic exposure approach that allows employees to align their retirement investments with their own vision of a sustainable future.

sustainable fundsMany investment products available to retirement investors already support sustainable investing practices, including mutual funds and exchange-traded funds. Some are managed by large global asset management firms as a suite of sustainable funds that are part of a larger product platform, while other solutions are from smaller, boutique firms that are exclusively focused on sustainable investing. Across the spectrum of sustainable investing products, there are a range of asset classes (equities and fixed income), investment styles (across geographies and market capitalizations) and themes. Some of the popular sustainable investment themes that are currently implementable include climate change and fossil fuel aware investing, faith-based investing and gender diverse investing.

Since sustainable investment funds can utilize a wide variety of investment styles, asset classes and benchmarks, it is important to leverage professional manager research to help identify high-quality sustainable investing strategies. Morgan Stanley’s Global Investment Manager Analysis (GIMA) team is responsible for the quantitative, qualitative and operational due diligence necessary to offer high-quality sustainable investing products on the advisory platform. Each sustainable investing strategy covered by GIMA goes through a detailed review of a firm’s analytical capabilities, sustainable investment process and implementation, personnel and firm, as well as business operations.

Every GIMA-covered sustainable investing product receives its own client-approved report that specifically details its sustainable investing approach and provides quarterly performance updates.

While adding sustainable investment options to a retirement plan may seem like uncharted territory, plan sponsors should follow the same guidelines and principles as they do when selecting traditional funds. It is just as important to consider fund performance, the experience of fund managers and risk diversification. In addition, plan sponsors may consider the following steps when seeking to include sustainable options into their retirement plan’s fund offering.

sample sustainable Investing esG factors20

enVIRonMenTal

• Climatechange

• Greenhousegas(GHG)emissions

• Wasteandpollution

• Resourcedepletion,includingwater

• Deforestation

• Landuseandrestoration

• Biodiversitypreservation

socIal

• Workingconditions,includingslaveryandchildlabor

• Localcommunities,includingindigenouscommunities

• Health,safetyandwellness

• Employeerelationsanddiversity

GoVeRnance

• Boarddiversityandstructure

• ExecutivePay

• Briberyand corruption

• Politicallobbyingandstructure

• Taxstrategy



Steps to Incorporating Sustainable Investment OptionsThe following steps are designed to help plan sponsors lay the groundwork for offering sustainable investment options as part of their defined contribution plans’ fund lineup.

bRInG The IDea To YoUR InVesTMenT coMMITTee To gain buy-in for adding a sustainable fund to your retirement plan, it is important to create a common definition for, and understanding of, sustainable investing and the opportunities it offers for investors and companies. Draw on the information presented in this brief to make the case for the value of sustainable investing.

DeTeRMIne WhaT MaTTeRs To Plan PaRTIcIPanTs When determining the right sustainable investing approach for your plan participants, it can be useful to first understand their values and priorities. Consider the company or organization’s mission and values. Are there certain types of investments you would want to exclude in support of the mission and values? Are there specific business risks that ESG integration could help manage? Or do the mission and values suggest any positive social or environmental impacts that the fund might target?

If the company has sustainability goals, volunteering activities or a foundation with a clear philanthropic strategy, this might also serve as a guide for aligning corporate values with sustainable investing themes. Alternatively, you might consider engaging employees directly or tapping into existing employee engagement mechanisms, such as annual surveys, to gather insight about which sustainability issues to prioritize.

UPDaTe YoUR InVesTMenT PolIcY sTaTeMenT By updating your Investment Policy Statement (IPS) to include language about sustainable investing, you set clear parameters to assist you in selecting and evaluating sustainable investment options. This will provide standard, strategic answers to questions about your approach and will help measure progress against your objectives (see step 6). Your Morgan Stanley Financial Advisor can help you draft an appropriate IPS.

IDenTIfY The RIGhT fUnD(s) Once you have a clear set of priorities and objectives for sustainable investing, work with your investment consultant to identify potential funds to add to your plan.

coMMUnIcaTe The neW InVesTMenT(s) To YoUR eMPloYees This is a great opportunity for you to create goodwill with your employees, as well as educate them on the benefits of sustainable investing.

MonIToR ResUlTs As the saying goes, “What gets measured gets managed.” In order to maintain your sustainable investing approach for the long term, identify a set of metrics — financial and nonfinancial — to assess fund performance. Work with your investment consultant to identify the right metrics and build them into your monitoring and due diligence practices.

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9MORGAN STANLEy | 2016

Defined contribution retirement plans — including 401(k)s and 403(b)s —are ripe for inclusion in the rapidly growing, and promising, sustainable investing market. By offering sustainability-oriented funds in your retirement plan investment lineup, plan sponsors can help plan participants meet their financial goals while also pursuing social and environmental objectives.

Morgan Stanley is at the forefront of the sustainable investing market. Drawing on expertise from across our firm and sources like the Institute for Sustainable Investing, Morgan Stanley can help you assess the opportunities for, and take steps toward, integrating sustainable investing solutions into your retirement plan.

For more information, contact a Morgan Stanley Financial Advisor or visit www.morganstaley.com/sustainableinvesting.

Conclusion



1U.S.SIF,“ReportonU.S.SustainableandResponsibleInvestingTrends”(2014)2MorganStanleyInstituteforSustainableInvesting,“SustainableSignals:TheIndividualInvestorPerspective”(February2015)3MorganStanleyInstituteforSustainableInvesting,“SustainableSignals:TheIndividualInvestorPerspective”(February2015)4U.S.SIF,“ReportonU.S.SustainableandResponsibleInvestingTrends”(2014)5PewResearchCenter,“MillennialssurpassGenXersAstheLargestGenerationintheU.S.LaborForce”(May2015)6MorganStanleyInstituteforSustainableInvesting,“SustainableSignals:TheIndividualInvestorPerspective”(February2015)7MorganStanleyInstituteforSustainableInvesting,“SustainableSignals:TheIndividualInvestorPerspective”(February2015)8RichardFry,PewResearchCenter,“MillennialsOvertakeBabyBoomersasAmerica’sLargestGeneration”(April2016)9Accenture,“The“GreaterWealthTransfer:CapitalizingontheIntergenerationalShiftinWealth”(2015)10MorganStanleyInstituteforSustainableInvesting,“TheBusinessCaseforSustainableInvesting”(April2015)11FoodandAgriculturalOrganizationoftheUnitedNations,“WorldAgricultureTowards2030/2050”(2012)12TechnologicalForecastingandSocialChange,“Long-termGlobalWaterProjectionsUsingSixSocioeconomicScenariosinanIntegratedAssessmentModelingFramework”(2014)

13WorldEnergyCouncil,“WorldEnergyScenarios:ComposingEnergyFuturesto2050”(2013) 14MorganStanleyInstituteforSustainableInvesting,“SustainableReality:UnderstandingthePerformanceofSustainableInvestmentStrategies”(March2015)15MorganStanleyInstituteforSustainableInvesting,“SustainableSignals:TheIndividualInvestorPerspective”(February2015) 16U.S.DepartmentofLabor“NewGuidanceonEconomicallyTargetedInvestmentsinRetirementPlansfromU.S.LaborDepartment”(October2015)17U.S.DepartmentofLabor“NewGuidanceonEconomicallyTargetedInvestmentsinRetirementPlansfromU.S.LaborDepartment”(October2015)18TransamericaCenterforRetirementStudies,“15FactsaboutMillennials’RetirementReadiness…and7StepsforLong-TermSuccess”(July2014)19MorganStanleyInstituteforSustainableInvesting,“SustainableReality:UnderstandingthePerformanceofSustainableInvestmentStrategies”(March2015)20UnitedNationsPrincipalsforResponsibleInvestment,“WhatareEnvironmental,Social,Governance(ESG)Factors?”(https://www.unpri.org/about/what-is-responsible-investment,accessedonSeptember22,2016)

Notes




©2016Morgan StanleySmith BarneyLLC.MemberSIPC. IIP8729554 CRC1622980 CS872955411/16

ImPORTANT DISClOSuRESPlease consider the investment objectives, risks, charges and expenses of the funds carefully before investing. The prospectus contains this and other information about the funds. To obtain a prospectus, contact your financial advisor. Please read the prospectus carefully before investing. Allinvestinginvolvesrisk,includingtheriskofloss.Thereturnsonaportfolioconsistingprimarilyofsustainableinvestments

maybe lowerorhigherthanaportfoliothat ismorediversifiedorwheredecisionsarebasedsolelyoninvestmentconsiderations.Becausesustainabilitycriteriaexcludesomeinvestments,investorsmaynotbeabletotakeadvantageofthesameopportunitiesormarkettrendsasinvestorsthatdonotusesuchcriteria.Pastperformanceisnotaguaranteeoffutureresults.Diversification

andassetallocationdonotensureaprofitorprotectagainstaloss.Informationcontainedinthematerialisbasedondatafrommultiple

sourcesandMorganStanleymakesnorepresentationastotheaccuracyorcompletenessofdatafromsourcesoutsideofMorganStanley.ReferencestothirdpartiescontainedhereinshouldnotbeconsideredasolicitationonbehalfoforanendorsementofthoseentitiesbyMorganStanley.Thismaterialcontainsforward-lookingstatementsandtherecanbenoguaranteethattheywillcometopass.Tax laws are complex and subject to change.Morgan Stanley

SmithBarneyLLC(“MorganStanley”),itsaffiliatesandMorganStanleyFinancialAdvisorsandPrivateWealthAdvisorsdonotprovidetaxorlegaladviceandarenot“fiduciaries”(underERISA,theInternalRevenueCodeorotherwise)withrespecttotheservicesoractivitiesdescribedherein,exceptasotherwiseprovided inwritingbyMorganStanley.Individuals areencouraged toconsult their taxand legal advisors (a)beforeestablishingaretirementplanoraccount,and(b)regardinganypotentialtax,ERISAandrelatedconsequencesofanyinvestmentsmadeundersuchplanoraccount.

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Sustainable Investing for Retirement Plans€¦ · workers save and invest for retirement. As a plan sponsor, ... mutual funds over a seven-year ... good ESG practices were better