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 article 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. The analysis suggests that demand for ESG funds is relatively low, with ESG fund allocations and holding levels being lower than random chance would suggest. 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, although ESG allocations are significantly higher in plans where general ESG usage is more elevated. ESG funds have the potential to drive participants away from professionally managed investment options, such as target-date funds, resulting in lower risk-adjusted returns for participants if they are simply added to core menus. Overall, this analysis suggests that plan sponsors should take a thoughtful and cautious approach when considering adding ESG funds to an existing core menu.