Morningstar launches ESG 401(k) designed for small employers

The first all-in-one ESG 401(k) is going live Tuesday, a plan that caters to small employers with a short list of funds vetted by Morningstar Investment Management.

The company, along with Plan Administrators Inc. (PAi), first announced the plan, known as a pooled employer plan, or PEP, in October 2021. This week’s launch coincides with the Department of Labor’s new ESG rule going into effect, a detail that allows plans to consider ESG factors including — crucially — the default investment options, which most often are target-date funds.

“This is going to engage a certain set of investors that might historically have been on the sidelines,” said Brock Johnson, president of global retirement and workplace solutions at Morningstar. “They might not feel connected to their money in any way, and ESG gives them the opportunity to see what their money is doing.”

INVESTMENT SELECTION

The plan includes 10 U.S. mutual funds from several providers: Parnassus, Boston Trust Walden, Calvert, TIAA, Fidelity, Vanguard and RBC. Morningstar also has a custom target-date option that uses those funds as the underlying investments.

“Any fund in the PEP is subject to the same investment screens and due diligence that we apply in a non-ESG plan. You don’t get a pass for being an ESG-oriented strategy,” said Peter Di Teresa, head of manager selection for Morningstar Research Services.

Morningstar chooses the funds for the plan by screening a wide range of investments for expenses and risk, then determining whether the remaining list of funds are appropriate for a retirement plan. It then considers funds based on Morningstar’s analyst and quantitative ratings as well as sustainability scores, the latter of which are based on material considerations, Di Teresa said.

A couple of options on the plan menu — the money market fund and the Treasury Inflation Protected Securities fund — are not ESG-specific, as those categories don’t lend themselves to it, he said.

The plan will also include a mix of actively managed and index fund choices.

Although the investments in the plan exclude certain high-emitting holdings, such as coal, they don't exclude the fossil fuel business entirely. However, oil and gas companies that are in funds within the plan have better sustainability ratings than peers, Di Teresa said.

A NEW TYPE OF PLAN

PEPs are a relatively new kind of 401(k) that let unrelated employers participate in the same plan. The benefits of that arrangement are costs and professional management. For example, small businesses get better pricing on plan administration and investments than they might be able to secure on their own, and they hand off most of their fiduciary liability to the companies overseeing the plan.

“The complexity with ESG is that many plan sponsors may not have the resources to dive into the details,” Johnson said. “It’s not easy for them to make a decision.”

For the Morningstar ESG Pooled Employer Plan, PAi Trust acts as the pooled plan provider, or the sponsor of the PEP. The company oversees the plan’s administration, including the hiring and retention of the investment manager, Morningstar Investment Management.

That unit of Morningstar is the plan’s 3(38) fiduciary, which means that it bears full responsibility for selecting and monitoring the plan’s investment lineup. The only fiduciary liability remaining for participating employers is their choice of the PEP itself.

COVERAGE MANDATES

PEPs could see a boost in demand because of requirements in a growing number of states that employers provide retirement plans to their workers. States like California, Illinois and Oregon have their own government-sponsored individual retirement accounts, but PEPs are an alternative to those.

“You might see some larger plans that would want to move into something like this, but we continue to do a lot of business with startups,” said Amy Hermann, director of sales and marketing of PAi. “We do get quite a few requests on a weekly or monthly basis looking for ESG lineups.”

Costs for the Morningstar PEP include a setup fee of $390 and a $200 monthly administration charge for employers. Workers who participate in the PEP will pay a record-keeping cost of $4 per month, an administration and trading fee of 7 basis points, a 25-bp investment fiduciary fee and the investment management fees of funds they choose, along with any fees set by advisers.

“It’s a cost-conscious offering,” Di Teresa said. “It’s appropriate everywhere, but it makes particular sense in the PEP universe.”

The plan debut comes days after half the states in the country filed a lawsuit against the DOL, seeking to block and dismantle the new ESG rule. However, lawyers who specialize in employee benefits said they see a difficult path for the litigation, as the rule was carefully drafted and doesn't require employers to consider ESG factors.

“This is good for investors,” Johnson said of the new ESG pooled employer plan. “This is more about choice than anything else.”