This New Rule From The Labor Dept. May Have Just Saved Your Retirement
Over the summer, the Department of Labor (“DOL”) issued a draft pertaining to how ERISA fiduciaries could (or could not) incorporate social advocacy factors into investment decision making. The ensuing uproar could be heard from coast to coast.
There was a good reason for that.
“The latest popular incarnation of socially responsible investing is ‘ESG’ investing,” says Robert R. Johnson, Professor of Finance, Heider College of Business at Creighton University in Omaha. “It involves selecting companies for environmental, social, and governance (“ESG”) factors, such as their record on air pollution, worker pay, community support, or shareholder accountability.”
Fueling this desire is the notion that ESG investing has performed better than average. ESG-based investing advocates point to several “studies” that support this.
“There is a belief that ESG compliant companies will perform better over time,” says Randy Carver, President of Carver Financial Services Inc. in Cleveland, “and the idea of supporting companies that are friendly to the environment and their workers is very compelling.”
Truth be told, for every study purporting to support this ESG-based investing, there’s a competing study that refutes the belief. The most recent in the latter category being a new research paper from the Center for Retirement Research at Boston College. It concludes “the evidence suggests, however, that social investing: 1) yields lower returns; and, 2) is not effective at achieving social goals.”
Given the conflicting data, it’s easy to understand why the DOL might be concerned that retirement plan fiduciaries, particularly those in large pension plans, might be tempted to use plan assets to promote any particular agenda (ESG just being one example).
Pressure from employees only complicates the plan sponsor’s position. Worse, the financial services industry hears what the general marketplace is asking for and is all too willing to comply, even if it means selling products into retirement plans that impact everyone, not just those looking for social advocacy investing.
“Like any industry, the financial industry is looking for the next big thing,” says Johnson. “With many socially-conscious investors entering the financial landscape, ESG investing offers a way to perhaps entice a more socially-conscious generation to embrace investing. And, that is certainly not a bad thing. If the client wants to engage in socially responsible investing, the industry should allow that avenue. But, that motivation for investing should not be forced upon anyone.”
This is the key difference between individual retail accounts and ERISA regulated retirement plans. As an individual, you should be free to make (and live with) your own decision. When it comes to retirement plans, however, the decision made by the plan sponsor will impact other people’s lives. That’s why a fiduciary has the duty to act only in the best interests of the plan’s beneficiaries.
“There’s a genuine demand for ESG, and outside of an ERISA context there are clear reasons for meeting that demand,” says Richard Barrington, a senior financial analyst for MoneyRates.com from Macedon, New York. “However, the industry may be interested more because ESG products offer one of a dwindling number of opportunities to charge premium fees.”
The opportunity to charge premium fees leads one to ask “Is selling ESG products the equivalent of selling the sizzle rather than the steak?” This is the question the DOL likely pondered. Unfortunately, it’s a question that’s difficult to answer because there is no clear consensus on the various ESG definitions.
“The problem with socially responsible investing is that beauty lies in the eye of the beholder,” says Johnson. “That is, some individuals consider some factors socially responsible while others don’t. For example, some might consider The Coca Cola Company KO to be irresponsible because it produces sugary soda that leads to obesity and other health problems.”
Still, the voices desiring ESG are not easily quelled, and the DOL apparently heard them loud and clear. When it revealed the new “ESG Rule,” something was conspicuously absent: ESG.
Yes, the DOL used ESG as a specific example for a general fiduciary rule, but that new rule isn’t new at all. It’s been there all the time.
The Securities and Exchange Commission already requires all Registered Investment Advisers to have clear and consistent documentation for any investment decisions they make. Those decisions have to have some quantitative reasoning behind them.
In the language of its new Rule, the DOL reiterates the fiduciary duty to make investment decisions based on “pecuniary” factors. That means the plan sponsor can consider ESG, but it needs to document the decision-making process to show the screening for that particular factor is not likely to sacrifice investment returns.
And that’s a good thing for your retirement. You want anyone responsible for investing your retirement assets to only consider investments that might optimize the size of your nest egg by the time you retire.
“While retirement savers may strongly value ESG investments, they must also demand an unbiased investment decision process that includes traditional fundamentals,” says Craig Jonas, CEO at Denver-based CoPeace.
Of course, for those really interested in promoting social advocacy, there may be a better alternative than betting your retirement on it.
“Outside of an ERISA context, investors are free to apply their values independently of financial impact,” says Barrington. “In any case, activism by shareholders can have more impact than divestment.”
You can do what you want with your play money. But no one should play with your retirement assets. The DOL’s new rule just made it harder for plan fiduciaries to do that.