The Corner

Capital Matters

ESG vs. ERISA?

United States flags fly outside of the New York Stock Exchange, March 19, 2020 (Lucas Jackson/Reuters)

For investors who wish to see their money put to work in, to use the self-congratulatory term, a “socially responsible” manner, the larger the selection of investment vehicles the better — and quite reasonably so.

But no one should be “forced” into this kind of investment. Increasingly, however, they are.

I took a look at this issue in an article earlier this month, of which this is an extract:

If … investors are putting their own money at risk, that is their decision to take. It is more complicated when they are managing money on behalf of others, and when those others have little or no say. If the latter have chosen to invest on socially responsible lines, there is no problem. But what if someone is a state employee, say, and that state’s retirement fund invests the money reserved for his or her pension — money, incidentally, that will have come from taxpayers — and that fund, like many state retirement funds, is using ESG [ESG is the acronym for Environmental, Social, Governance, a set of three vaguely defined criteria used to determine what is—or what is not—a “socially responsible” investment] as a material investment benchmark? The actual and prospective pensioners will have little say, and neither, realistically, will taxpayers. Equally, where company 401(k)s offer a range of mutual funds, there is a growing chance that those funds, regardless of how they are labeled, and, increasingly, even if they are passive funds, will, if they vote at shareholder meetings, be following the SRI (socially responsible investing) rulebook. What then, of investor choice?

That makes a new announcement by the Department of Labor not only of interest, but, in my view, overdue.

Over at Bloomberg, Matt Levine has the story:

The U.S. Department of Labor sets the rules for retirement accounts in the U.S., both corporate defined-benefit pension funds and also defined-contribution 401(k) plans. On Tuesday it announced that it will ban ESG investments from retirement accounts [In fact, it is a proposal to ban]. I mean, that is an overly dramatic simplification of the proposed rule; pension funds will still be allowed to consider ESG factors in their investments, and 401(k) plans will still be allowed to offer ESG funds on their menu of options. But the overall thrust of the DOL’s proposed rule is that retirement-fund fiduciaries have to consider only economic factors in offering retirement accounts. They can consider ESG factors “only if they present economic risks or opportunities that qualified investment professionals would treat as material economic considerations under generally accepted investment theories”; they can offer ESG funds in 401(k) plans only if they use “objective risk-return criteria, such as benchmarks, expense ratios, fund size, long-term investment returns, volatility measures, investment manager tenure, and mix of asset types … in selecting and monitoring all investment alternatives for the plan, including any ESG investment alternatives.”

You can refuse to buy polluters if you think, and can document, that their factories will blow up and they’ll be fined a lot of money, because losing a lot of money is bad under, uh, “generally accepted investment theories”; you can’t refuse to buy polluters because you think that pollution is bad for the world. You can offer ESG funds if their performance meets the same standards as your other funds; you can’t sacrifice performance for social good.

Or someone’s idea of “social good”.

The proposed change goes, I think, too far. If the participants in a pension fund want to choose investments where “social responsibility” can come at the expense of performance that should be their (and only their) decision to make — and, ideally, it should be an informed decision. There is, for example, some evidence, which intuitively makes sense, that ‘G’ (a focus on governance) adds to performance, but emphasizing the ‘E’ (‘environmental’) and ‘S’ (social) detracts from it.

The most important thing here is choice. People who wish to see an ESG element in their pension planning should have the opportunity to opt for that — but no one should be compelled to do so.

And the proposed rules come with an interesting twist, as Levine explains:

BlackRock has announced that ESG funds will become the default option in some of their fund menus; the DOL has announced that ESG funds can’t be the default option in a 401(k).

BlackRock, the largest investment manager in the world, has become a major advocate of ESG, as I discussed here and here.

Eugene Scalia, the Secretary of Labor has explained what is driving this proposed change:

 Private employer-sponsored retirement plans are not vehicles for furthering social goals or policy objectives that are not in the financial interest of the plan…Rather, ERISA plans should be managed with unwavering focus on a single, very important social goal: providing for the retirement security of American workers.

Quite.

It is, however, worth noting that state pension funds (typically major supporters of ESG investing) are exempt from the ERISA rules.

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