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Department of Labor Proposes New Rule Limiting ESG Investments

Nov 19 | 2020  by

The Employee Benefits Security Administration has sent a proposed rule to the White House that intends to amend existing guidance governing financial fiduciary investment duties under the Employee Retirement Income Security Act of 1974 (ERISA). The proposed, Financial Factors in Selecting Plan Investments rule will prevent fiduciaries from using an environmental, social and governance (ESG) or sustainable investment plan as the default choice in any public or private retirement plan. On top of this, the DOL’s proposal will make it difficult for retirement plan managers – this includes pensions and 401(k) plans – to consider ESG factors when evaluating potential investment plans.

The proposal comes in response to the growing popularity of fiduciaries and investors choosing ESG funds as their default investment tools in recent years. Despite over 95% of financial firms, groups, and individuals who submitted comment letters to the DOL’s proposal called it a bad idea. The Trump administration is now moving at ‘warp speed‘, looking to implement this rule in four-and-a-half months as opposed to the conventional 18 months with “impactful” rule changes such as this one.

But why does the DOL and Trump administration feel this way when there are so many investors, fiduciaries, and firms utilizing these tools? From the Department of Labor’s perspective, an investment that integrates social consciousness into its selection process will either forfeit financial performance or increase risk for shareholders. The problem is ESG funds do not automatically carry more risk or underperform. In April, Morningstar reported sustainable funds outperformed their conventional fund peers in 2019, flashing impressive returns of 35% in some cases.

Let us recap so far, investors are growing more socially conscious with their plans, ESG’s outperform traditional fund plans, but the Department of Labor wants to complicate utilizing ESG funds. What gives? According to Secretary of Labor Eugene Scalia, in the DOL report announcing the proposed rule: “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 the retirement security of American workers.”

However, I urge you to consider that this simple-minded change does not reflect the long-term financial costs of industries performing well right now based on current returns. But those long-term growth strategies that ignore environmental costs are bad investments, now!

Do you use ESG Funds in your investment portfolio? How do you feel about this proposed rule change?