End of Week Notes
Trump Administration opens another front in its war on ESG investing
The Department of Labor wants to limit the use of ESG investments in retirement plans
Donald Trump and the D team trying to run his administration are severely out of step with the times, the facts, and most Americans, as their response to the pandemic and racial justice protests have made abundently clear for all to see.
And while attention is appropriately focused on those two shameful crises, the Trump Administration is rushing to promulgate out-of-step regulations ginned up by its many acting secretaries before the clock runs out on them.
Case in point is its multi-front attack on ESG investing, advancing first from the SEC and now the Department of Labor (DOL), which this week proposed a rule designed to keep ESG investments out of retirement plans.
Let’s make this clear from the onset: These efforts have nothing to do with helping investors make better decisions or with helping working people achieve better returns for their retirements.
They have everything to do with the Administration’s desire to preserve an economic system that has promoted inequality, racism, and climate destruction but has benefited those you might call the MAGA Elites — wealthy, mostly white, one-percenters, especially in industries that have spent billions on lobbying and political contributions over the years to avoid regulations and taxes and to deny the climate crisis. Many of them, too, are traditional investors who have benefited from companies focusing solely on maximizing shareholder value.
Why is ESG investing such a theat? Because today’s investors have figured out that ESG insights can be used to better understand investment risks and opportunities. They’ve figured out that climate change poses enormous risks to a wide range of their investments, and so they are asking companies to mitigate those risks. In fact, investors now recognize a wide range of material ESG risks and are asking companies to address those, as well.
Rather than fight back by financing K Street lobbyists and like-minded politicians, as they did back when America was “great”, companies are beginning to get the picture. Why not just work with investors to understand their concerns and solve problems? As it turns out, this approach is well-aligned with concerns being raised by other stakeholders, whose voices used to be drowned out by investors demanding companies pay heed only to their interests.
Corporate managers are starting to realize that doing right by their customers and clients, their employees, the communities in which they operate, and by the planet just might be good for business, especially over the long run, and ESG investors, on the whole, are encouraging them in the same direction.
Rapidly growing in popularity, ESG investing is thus a threat to the worldview of the MAGA Elites because it is aligned with the whole idea of corporate purpose and stakeholder capitalism. As Labor Secretary Eugene Scalia noted derisively in the Wall St. Journal this week:
ESG investing often marches under the same banner as “stakeholder capitalism,” which maintains that corporations owe obligations to a range of constituencies, not only their shareholders.
A chilling effect on ESG in retirement plans
All that being said, the letter of the DOL’s proposed rule should not keep ESG investments completely out of retirement plans, but the spirit of it likely will.
The rule is based on the faulty premise that the main purpose of ESG investing is really just politics by other means. In other words, ESG investors are simply political actors trying to implement their environmental and social activist agendas by directing investments to better companies, avoiding worse ones, and pressuring directly those they hold via shareholder engagement and proxy voting.
Here are the key provisions (in my words):
Investments focused on material ESG factors may be permitted in retirement plans “only if they present economic risks or opportunities that qualified investment professionals would treat as material economic considerations under generally accepted investment theories.”
The DOL is clearly dubious of the whole idea of ESG materiality, but grudgingly accepts it. Because virtually the entire investment world disagrees, particularly around climate risks, and as consensus grows about the industry-specific materiality of other ESG factors, this provision could be irrelevant as soon as the ink dries.
Investments that are chosen because of their “non-pecuniary” benefits, presumably funds that have a goal of creating societal or environmental impact, must not sacrifice risk-adjusted return and must be “economically indistinguishable” from non-ESG alternatives. The selection also must be well-documented, with the DOL stating it doubts that there will be many cases where a true tie exists.
I don’t know of a single case ever where plan fiduciaries have selected ESG investments they believe would underperform, regardless of whether the investments focus on material ESG factors or offer some kind of “non-pecuniary” benefit, like positive impact on the world. This simply does not happen. There is no evidence provided by the DOL of a single case that has arisen over the past three decades making that argument, so why raise unreasonable bars for proving and documenting that a selection must be “economically indistinguisable” from other alternatives?
No one wants consessionary returns in a retirement plan, whether it’s a defined-benefit or defined-contribution plan. And there is not a single fund in my U.S. sustainable funds universe, which now totals 334 funds, that is structured so that it would be expected to underperform its conventional fund counterparts.
For defined-contribution plans, that standard is eased a little, so long as the plan fiduciary has considered only “objective” financial criteria in selecting the fund and considered its impact on the mix of asset types offered.
Again, ESG “impact” equity and fixed-income funds are not structured to underperform standard benchmarks, so why hold them to higher selection standards than conventional funds? For many of them, “impact” has more to do with reporting than intent.
Over the last five years and during this year’s crazy market, ESG funds of all stripes, on average, have outperformed their conventional counterparts.
However, the use of an ESG fund “whose objectives include non-pecuniary goals” cannot be chosen as a qualified default investment alternative (QDIA).
This is the worst provision of the rule. Huge amounts of the $8 trillion or so in defined-contribution plan assets get defaulted into these investments. The way this is written would seem to preclude even a fund focused on material ESG factors if it, for example, issued an impact report. The rule also precludes such funds being added “as a component” of QDIAs, so a target-date fund could not add an ESG fund even if it believes such a fund would offer better long-term results. This is hardly a rule that protects workers, and it could lead to QDIAs becoming suboptimal choices.
In sum, the proposed rule places unnecessary additional barriers on ESG investments in retirement plans. There is no evidence that plan fiduciaries are inappropriately selecting ESG investments under DOL guidance that has been in effect over the past three decades. As ESG analysis is becoming a mainstream part of investment analysis, regulators ought to be encouraging plan sponsors to consider long-term ESG risk as part of their fiduciary duty, not throwing up barriers.
Here are some additional takes:
