11.23.2020
Labor Department’s rule on ESG investing creates a new hurdle for retirees
A crucial change to how private pension plans operate could have profound consequences for your 401(k).

With all eyes on the presidential election, Americans shouldn’t miss a crucial change the Trump administration made a few weeks ago to how private pension plans operate. If the rule stands, it could have profound consequences for your 401(k).

To understand what’s at stake, imagine a trip to the grocery store and how you decide what to put in your shopping cart. Price is probably always on your mind, since no one likes to pay more than they should for eggs, milk, or fruit. But you might also take into account the quality of the food or any dietary restrictions and allergies you may have.  

Now, imagine a rule that says price is the only factor you are able to consider when you shop for food; everything else is, by law, irrelevant. That’s similar to the quandary now faced by fiduciaries who manage the $10.7 trillion Americans have saved in private pension plans. 

Labor Secretary Eugene Scalia says the rule clarifies fiduciaries’ obligations to plan participants by requiring that they select investments based solely on their risks and returns. The goal, Scalia argues, is to ensure fiduciaries focus on the financial interests of plan participants, rather than on “other, non-pecuniary goals or policy objectives.”

The “other” goals the rule aims to eschew are environmental, social, and governance factors that underpin investments. Commonly known by the acronym ESG, these are considerations such as a company’s impact on the environment, its customers, suppliers, employees, and the soundness of its managerial and regulatory controls and practices. 

Just as many consumers have become more aware of what they eat and how it impacts their health, investors have become more aware of ESG factors when they choose investments, transforming ESG into a major force in the institutional investment world. 

In my work leading RFK Human Rights’ Compass Investor Program—a network of over 250 institutional investors, asset managers, and consultants who collectively control close to $7 trillion in assets under management—I routinely hear how important ESG factors have become to major pensions and endowments. Simply put, they want their retirement funds to be earned by doing good at the same time.

By requiring plan fiduciaries to base their decisions solely on investment returns, the Labor Department’s rule solves a problem that doesn’t exist and creates a new one American retirees don’t need. 

The problem that doesn’t exist is fiduciaries’ implied lack of focus on investment returns. In my four years leading the Compass Investor Program, which holds annual conferences on ESG issues including our core focus on human rights, I’ve never heard a plan fiduciary say they don’t seek to secure the best possible returns for their retirees. Like the price-conscious shopper for whom cost is always a consideration, all plan fiduciaries pay attention to their investments’ risk and return profiles, even as they give weight to ESG factors that they also think may be relevant. For some organizations that invest based on religious and moral grounds, it may come down to divesting from a business whose mission clashes with their beliefs. For others, it may mean avoiding companies that use child labor in their supply chains because of the reputational and ethical concerns such an investment raises.

By intervening in such decision-making scenarios, the Labor Department is instead creating a new hurdle for retirees—the chilling effect that its rule will have on fiduciaries’ use of ESG in selecting appropriate investments for their plan participants. Faced with the prospects of civil penalties and legal actions, many fiduciaries may simply choose to avoid environmentally and socially-friendly investments altogether, even if they think the returns might be comparable to other options in their portfolios.

If that happens, as expected, it will only be to retirees’ detriment. Year-to-date, the S&P 500 ESG Index is up 6.35% compared with a 4.28% gain for the broader S&P 500 stock index. That’s no small feat during one of the most volatile years on record. Meanwhile, investors are lining up billions of dollars to target environmentally and socially-friendly investments in renewable energy, healthcare, agriculture and many other industries. With the Labor Department’s rule in place, Americans may miss out on the next technology or company that transforms our lives for the better. 

We know that leveraging dollars for maximum social and financial impact is not incompatible. We don’t need the Labor Department to make it so by effectively eschewing ESG investing from Americans’ 401(k) plans.