Earlier this summer, the U.S. Department of Labor (DOL) proposed to change a rule that would make it very difficult for managers of retirement plans - including 401k savings and pensions - to consider non-financial factors, such as environmental, social and corporate governance (ESG) when choosing an investment. Moreover, the DOL’s suggested changes would preclude 401k plans from using an ESG or sustainable investment as a default choice in any public or private retirement plan.
This new rule will potentially affect more than $10 trillion in U.S. retirement plans and poses a massive threat to the responsible investment industry - an industry that has touched over 490 million lives with a cumulative investment of $11 billion over the last 10 years. This proposal threatens to be a substantial disservice to our country and investors alike by preventing Americans from building wealth through a means that will truly make a difference, especially during a time when we need it most.
Apparently, the DOL is concerned that ESG investments increase risk and subordinate financial performance, which would go against the Employee Retirement Income Security Act (ERISA). ERISA asserts that retirement plan managers can’t sacrifice financial security for any reason.
Now, it’s important to note up front that the proposed DOL rules are based on a faulty assumption, one that says sustainable investments can’t compete with traditional investments from a financial perspective.
Recent research debunks that assumption. Investments that consider ESG factors have performed as well—and in many cases better—than investments based solely on traditional pecuniary considerations.
A white paper by the Morgan Stanley Institute for Sustainable Investing found that in examining approximately 11,000 mutual funds from 2004 to 2018 there was no financial trade-off in the returns of sustainable funds relative to traditional funds. Sustainable funds also demonstrated lower downside risk.
Similarly, 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 relatively poor performance.
Sustainability is a major risk factor for corporations today. As such, they are understandably placing greater emphasis on ESG risk analysis and performance. Most CEOs and company directors now realize that sustainability issues are strongly associated with financial performance. They understand that more and more consumers—especially younger consumers—are demanding that the companies they do business with perform well on ESG criteria.
A 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).
It turns out that “doing good” is also good business.
Given findings such as these, it can certainly be argued that retirement plan managers that don’t consider ESG factors when evaluating the potential financial performance of investments are not fulfilling their fiduciary responsibilities. In fact, if two investment options have the same or similar performance, ESG vs. non-ESG, the investment manager should indeed weigh ESG more heavily since there is a positive societal impact not reflected in non-ESG performance. In effect, in choosing more responsible investments, everybody wins.
This is especially important to younger investors participating in 401k plans and other retirement accounts who are spearheading the shift to “conscious investing.” In fact, a 2019 study by Morgan Stanley found 95 percent of Millennials are interested in focusing on sustainable investing. Curtailing sustainable investing can negatively impact this core component of the larger movement toward a more conscious and inclusive capitalism by limiting opportunities for these individuals to build wealth through a means they can feel good about—particularly in the long-term.
The emphasis on traditional financial analysis when evaluating potential investments is flawed in its singular focus. If retirement plan managers and investors rely on historic financial trends, sans environmental, social and corporate governance impact, it’s likely that excellent financial investments will be missed due to an ESG blind spot.
Implementing the proposed DOL rules would unnecessarily hamstring retirement plan managers from performing comprehensive analyses of investment opportunities. As such, implementing these rules would be a major disservice to both retirement plan managers and investors.
The bottom line is, companies that utilize ESG criteria in their management practices are typically well-managed companies and as a result consistently have better financial performance. And retirement planners who include sustainability factors in their investment analysis are the new gold standard.
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