Reading the News Bulletin
The DOL clarified its views around fiduciary standards and ESG investing in "Interpretive Bulletin 2015-01." ESG strategies are covered as part of the bulletin’s language on "economically targeted investments" (ETIs). ETIs are defined as investments that are selected for benefits they have the potential to provide in addition to their capacity for delivering a monetary return to a retirement fund. The bulletin stated that while "the financial health of retirement plans and participants remains paramount under federal law," ESG considerations have a role to play in the portfolio decisions of retirement plan fiduciaries. "Investing in the best interests of a retirement plan and in the growth of a community," explained former US Secretary of Labor Thomas E. Perez, "can go hand-in-hand."
Investment strategies that use ESG analysis have had many names over the years, from socially responsible investing (SRI) to "responsible," "sustainable," and "impact" investing. In general, each of these terms describes different ways of implementing considerations of environmental health and sustainability, social issues, and corporate governance issues in an investment process. The way in which ESG considerations are implemented in investment strategies can differ considerably and can range from negative screening to best-in-class weighting and ESG-issue integration.
Negative screening refers to the exclusion of certain companies from a portfolio because they do not adhere to a given value standard. For example, some investors may want to exclude tobacco or firearms companies from their holdings. Best-in-class approaches involve evaluating companies relative to their peers on their adherence to and support of various ESG principles such as pollution, labor practices, or political contributions. ESG-issue integration refers to the practice of gauging a company’s particular environmental, social and governance policies and whether or not these policies may contribute to their financial performance over time.
Guidelines for ESG
The DOL made clear in its 2015 bulletin that "fiduciaries may not accept lower expected returns or take on greater risks in order to secure collateral [ESG] benefits." However, they "may take such benefits into account as ‘tiebreakers’ when investments are otherwise equal with respect to their economic and financial characteristics." Beyond serving as tiebreakers, the DOL also recognizes that ESG factors may also "have a direct relationship to the economic and financial value of an investment" and thus serve as "proper components of the fiduciary’s analysis of the economic and financial merits of competing investment choices."
Going Forward, Sustainably
A growing number of investors are starting to appreciate the positive environmental and social impact they can make with their wealth. Moreover, financial professionals and retirement plan fiduciaries have an opportunity to empower plan participants by aligning their assets with their personal values. Interest in ESG investing spans all incomes and age groups – and it’s likely that retirement plan fiduciaries will be having conversations around these strategies more and more frequently in the months and years ahead.
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Investing involves risk, including the risk of loss.
This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions expressed above may change based on market and other conditions. There can be no assurance that developments will transpire as forecasted.
ESG investing focuses on investments in companies that demonstrate adherence to environmental, social and governance (ESG) practices, therefore the universe of investments may be reduced. An ESG strategy may sell a security when it could be disadvantageous to do so or forgo opportunities in certain companies, industries, sectors or countries. This could have a negative impact on performance depending on whether such investments are in or out of favor.