After drubbing by funds, what's next for Labor Dept.'s ESG rule proposal

ESG consultant Tony Davidow looks at the overwhelming opposition to the idea.

By Anthony B. Davidow

(About the author: Tony Davidow is president and founder of T. Davidow Consulting, an independent advisory firm focused on the challenges facing the financial services industry. His focus is on helping advisers and investors incorporate complex strategies in their portfolios.)

WILTON, CONN. (Callaway Climate Insights) — In a previous article, I discussed the Dept. of Labor’s overreach in limiting ESG funds in retirement plans. I had suggested that industry groups and asset managers would push back on this proposal. In fact, there were more than 1,500 comments submitted regarding the proposed regulation to limit ESG investing in retirement plans, virtually 95% of which were critical of the DOL’s proposal. 

Implicit in the DOL’s proposal restricting access to ESG funds was a belief that investors would be disadvantaged in choosing these options. However, the data actually show that many of these funds have outperformed their unconstrained benchmarks.

They have outperformed because the screening rewards companies with strong corporate governance, a diverse workforce and sound environmental policies — and screens out companies lacking sufficient checks and balances, diversity of ideas and wasteful practices.    

Some of the statements submitted to the Dept. of Labor during the public comment period:

BlackRock: We are concerned that the proposal goes far beyond reiterating and clarifying the DOL’s long-standing and consistent position that plan fiduciaries must put first the economic interests of plan participants and beneficiaries. The proposal creates an overly prescriptive and burdensome standard that would interfere with plan fiduciaries’ ability and willingness to consider financially material ESG factors, regardless of their potential effect on the return and risk of an investment. We encourage the DOL to address these consequences before moving forward with any final regulation.

Morningstar: Simply stated, the Department’s proposed rule is out of step with the best practices asset managers and financial advisors use to integrate ESG considerations into their investment processes and selections. Were the Department to keep the rule as proposed, it would lead to worse outcomes for plan participants as plan sponsors shied away from assessing ESG risks in selecting investments. Indeed, since most participants use qualified default investment options — and ESG considerations would be barred in these options — most participants would not get the benefits that ESG risk analysis can deliver… 

American Retirement Association: The ARA does not believe that DOL guidance should discourage ERISA fiduciaries from considering environmental, social, governance (ESG) factors as they evaluate plan investment options; and the ARA believes otherwise-appropriate investments that include ESG factors should not be prohibited from qualifying as Qualified Default Investment Alternatives (QDIAs) or as a component of a QDIA.

Lisa Woll, CEO of US SIF: The Forum for Sustainable and Responsible Investment in Washington, D.C., said in a statement, “The proposed rule suggests, but without evidence, that the growing emphasis on ESG investing may be prompting ERISA plan fiduciaries to make investment decisions for purposes distinct from providing benefits to participants and beneficiaries and defraying reasonable expenses of administering the plan. However, the DOL proposal is out of step with professional investment managers, who increasingly analyze ESG factors precisely because of risk, return and fiduciary considerations.”

What’s next?

It is not clear whether the backlash will cause the DOL to revisit their proposal or whether they will move forward with this rule. I applaud the DOL for taking a progressive stance regarding including private equity in retirement plans, and would encourage them to use the same logic for ESG funds. Why would they want to limit access to these strategies to high-net-worth investors and institutions?  

My past articles have shown that these strategies have often delivered strong performance, with reduced risks, relative to other funds available in the marketplace.

According to a recent Celent research report, “ESG In Portfolio Management: From Data to Deployment,” they estimate global ESG assets will surge to $53 trillion in 2021 (up from $30 trillion in 2018). The growth has been fueled by strong performance, increased demand from investors, and more attention given to the E, S and G pillars. Events like Covid-19, California’s wildfires and social unrest across America have served as catalysts for change.    

Rather than depriving investors of these unique strategies, regulators should focus on better education regarding the various types of strategies and the inherent biases. We would all benefit from a better informed investing public and more viable options for retirees. Investors want and deserve to have choices for their retirement plans.

Financial advisers and asset managers should take the lead in educating investors about these strategies. They should help investors understand the various screening and weighting methodologies and potential tradeoffs. 

Photo: Bernd Kirschner/flickr.