This Proposed Rule Change Could Threaten Retirement Plans Using ESG Investments
The U.S. Department of Labor (DOL) has proposed rule changes that would prevent 401(k) plans from using an environmental, social and governance (ESG) or sustainable investment as a default choice in any public or private retirement plan.
In addition, the DOL proposal would make it very difficult for retirement plan managers—including pensions and 401(k) plans—to even consider ESG factors when evaluating potential investments.
These proposed rule changes fly in the face of marketplace trends that show that ESG and socially responsible investments are very popular with a large swath of investors and are growing at a fast rate.
According to a recent Morningstar report, the number of sustainability-focused index funds has doubled over the past three years. These funds now top $250 billion worldwide, with the U.S. market comprising 20 percent of that total.
Morgan Stanley says the next decade of investing will be defined by the acronym “ESG.” It’s clear investors are increasingly considering socially conscious investing options these days. They realize that ESG issues impact the bottom line. They also are interested in examining an investment’s overall stakeholder impact, not just looking at traditional financial metrics.
The proposed DOL rules could potentially affect more than $10 trillion in U.S. retirement plans and threaten the fast-growing socially responsible investment industry—an industry that has surpassed $11 billion in investments over the last decade and impacted over 490 million lives.
It appears the DOL believes that ESG investments add volatility and weaken financial performance, which defies the Employee Retirement Income Security Act’s (ERISA) assertion that retirement plan managers cannot compromise financial security for any reason.
To that point, please keep in mind that the proposed DOL rules are based on an unreliable assumption that ESG investments do not offer financial returns that are even remotely comparable to that of traditional investments. However, there is plenty of evidence that unmistakably demonstrates that ESG components perform just as well, and oftentimes outperform, traditional investments from a purely monetary standpoint. Consider these findings:
- Year-to-date, 72 percent of sustainable funds ranked in the top half of their Morningstar category.
- A white paper by the Morgan Stanley Institute for Sustainable Investing found there was no financial trade-off in the returns of sustainable funds relative to traditional funds while examining nearly 11,000 mutual funds between 2004 and 2018. The report also noted that sustainable funds demonstrated lower downside risk as well.
- A highly regarded 2016 study, led by George Serafeim of Harvard Business School, found that stocks of companies with the strongest performance on ESG issues outpaced those with poor ESG performance.
- A meta-study published in 2015 by the University of Oxford and Arabesque analyzed approximately 200 scientific studies on the economic impact of sustainability and found that strong ESG performance was positively correlated with better stock price performance (80 percent of studies), better operational performance (88 percent of studies), and lower cost of capital (90 percent of studies).
These findings make a strong case to argue that retirement plan managers who do not consider ESG factors when evaluating the potential financial performance of investments are not complying with their fiduciary responsibilities.
Relying on traditional financial analysis—referencing historic financial trends without considering environmental, social and corporate governance impact—when assessing potential investments will create an ESG blind spot that will overlook valuable financial investments and hinder retirement plan managers from performing comprehensive analyses of investment opportunities.
ESG issues can especially impact financial returns in the long-term—which is an important consideration for younger investors participating in 401(k)s and other retirement accounts. Younger generations are spearheading the shift to “conscious investing” in order to build wealth through a means they can feel good about. Conscious investing is part of the larger movement toward a more conscious and inclusive stakeholder capitalism.
To sum up, implementing the proposed DOL rules would be a significant disservice to our country and investors alike by preventing Americans from building wealth through a means that can also positively address social, environmental and labor issues in this country.
Craig Jonas, CEO of CoPeace, is a lifelong entrepreneur with success across business, academic and athletic industries. He has over 30 years of experience in management with a passion for teambuilding and drawing individuals with big ideas together.