As October wound to a close, the Labor Department unveiled its Final Rule on Financial Factors in Selecting Plan Investments—and while the proposed rule spent a lot of time on ESG, the final—well, it “contains no specific references to ESG or ESG-themed funds.”
In fairness, the response rate this week was quite a bit less than “normal”—and the responses received were relatively ambivalent, compared with previous polls on the subject.
That said, asked what they thought of the proposed rule (from back in June), a strong plurality (42%) were in the “I could take it or leave it” mindset, though nearly a quarter (23%) said they REALLY didn’t like it, and another 19% “didn’t like it.” The remaining 16% were split evenly between those who REALLY liked it, and those who merely “liked” it.
“Seemed it was going to broaden the fiduciary requirements for all investments,” commented one. “It is a solution in search of a problem,” said another reader. “If it were an actual problem, there would be more than.02% of assets in ESG, and IPS’s would treat ESG differently than all other investments (they don’t).”
‘Final’ Factors
Now, with a change in administrations, its future may be limited, but it seems fair to say that the final rule provided a somewhat different take on ESG investments. Indeed, the final rule on ESG investing by ERISA plans steps away from the proposed rule’s focus on ESG. Rather, acknowledging the fluid definition of environmental, social, and governance factors, the Labor Department’s position is that “the lack of a precise or generally accepted definition of ‘ESG,’ either collectively or separately as ‘E, S, and G,’ made ESG terminology not appropriate as a regulatory standard.” Therefore, the final rule—which will be effective 60 days after publication in the Federal Register—refers to “pecuniary factors and non-pecuniary factors” in defining the relevant fiduciary investment duties.
And so we asked readers what they thought of the final version. And despite those changes, respondents seemed largely unmoved (if anything the “like” seems to have diminished):
52% - I could take it or leave it.
28% - I Like it.
8% - I REALLY like it.
8% - I don’t like it.
4% - I REALLY don’t like it.
We then asked readers to predict the impact the final rule would have on the inclusion of ESG on DC plan menus—assuming, of course, that the final rule holds—the outcome, as you might expect, was varied:
31% - It will have no effect on adoption, but might increase consideration.
15% - It will increase the likelihood of consideration.
12% - It will have no effect on consideration, but might increase adoption.
11% - It will have no effect on adoption or consideration.
11% - it will decrease the likelihood of consideration.
9% - It will decrease the likelihood of adoption.
8% - It will decrease the likelihood of adoption.
3% - It will increase the likelihood of adoption.
“The fact that there is a rule will allow interested plan sponsors to proceed. A big deterrent to adding this type of investment to plans was the unknown,” noted one reader. “I think ESG funds are already being used in plans that choose to have them and have made appropriate documentation in the IPS to reflect it,” commented another. “Those who get it, will still get it,” commented another. “Showing that ESG is pecuniary will help provide ‘cover.’”
On the other hand, another cautioned that “Many Trustees will stay away from ESG Funds because they do not want to risk government action against the plan or its fiduciaries.” “We have no interest in ESG. It may make sense to offer some of the funds if participants want it but we have no intention of forcing participants into this type of investment,” noted another.
“ESG penetration is so low now, I don’t see things changing much with this rule,” explained one. “Non-pecuniary factors are not likely to be pervasive in ESG-related investments considered for ERISA plans in the first place, so I doubt this changes much,” concurred another.
“The market will need to respond. Too many ESG investments are poor performers. Vendors will find a way to package these options, probably by cutting their fees and by using creativity in putting together portfolios,” commented another.
“Backing of calling out ESG and instead reinforcing pecuniary factors is a key differentiator,” noted another. “The opinion this whole thing was predicated on was that ESG investing is a detractor and is non-pecuniary. However, depending upon the strategy and how its employed, ESG investing in fact can be additive and offer additional returns and/or risk mitigation that other non-ESG may not. Unfortunately, like all investing, you cannot predict results, but you can use measures that create an environment to maximize returns.”
“The marketing is massive and now more clients my ask about it because participants may ask,” noted another.
Recommend ‘Ed’
As for the effect that the final rule would have on their recommendations regarding ESG investments on DC plan menus:
32% - It will have no effect on adoption or consideration.
22% - It will increase the likelihood of consideration.
18% - It will have no effect on adoption, but might increase consideration.
14% - it will decrease the likelihood of consideration.
8% - It will increase the likelihood of adoption.
6% - It will decrease the likelihood of adoption.
Some reader comments on the subject:
“Opportunity for conversation with plan sponsors—some we say 2-3 sentences and conversation moves along. Others it becomes a 10-15 minute conversation.”
“I will keep on promoting ESG. Climate change is real. Mother Nature bats last.”
“The DOL has brought substantial attention to the issue of socially responsible investing. Many socially conscious employers may not have been previously aware of these funds, and will now consider them, and if they make sense, offer them as an additional option for their participants.”
“It’s rarely something that ever reaches our radar. Not-for-profit groups like to add these occasionally, but otherwise it’s a complete non-issue.”
“If nothing else, this has elevated the discussion to committees and fiduciaries where otherwise this had not entered into the conversation for no other reason than its lack of trend and direction by the industry at large. I’ve had more discussions than ever this past quarter about ESG by both committees and participants. In fact, those who have ESG committees at their own corporate-level are now considering it as it matches their own governance and social commitments they’re making as a result of the global pandemic, social injustices and environmental impact.”
Participant Perspectives
There is a reality—that while few DC plans offer these options, even when they are offered, relatively few participants seem to take advantage. We asked readers why they thought that might be the case (more than one response was permitted):
64% - They don’t recognize it for what it is.
32% - They are concerned about performance.
32% - It’s not a default.
28% - It’s not promoted sufficiently.
8% - They are concerned about costs.
Of course, as things stand today, we now have a final rule on those “financial factors,” most specifically the emphasis on pecuniary factors in making investment selections. Here are some closing reader comments:
New administration... will we get new regs?
I wish the administration had focused on more pressing issues.
There’s a good chance that the new administration will overturn this rule completely.
The rule now states the obvious—that you have to pick funds that are in the best interests of participants and beneficiaries. The DOL has been consistent in that position for decades—it is why ESG’s predecessors in plans, socially responsible funds, never took off despite the birth of the environmental movement. If an ESG fund does not satisfy a plan’s IPS, it won’t be included, period, final rule or no.
The “social justice” movement has sought to control capitalism through starving industries they don’t like using ESG as cover. The rule hits this movement head on and keeps fiduciaries properly focused on their jobs as stewards of other people’s money rather than improperly confused as social justice warriors.
There is demand for this especially in the 403b market. I have found a few socially responsible funds that perform well, and I use those.
I have learned Morningstar screens for ESG based on whether the prospectus contains the phrase “ESG.” That will get a fund on the ESG list whether they truly follow the methodology or not. It’s just going to get harder to truly find a fund that fits what an investor might be looking for.
It’s really not that complicated. I tell clients to go ahead and make the extra money that comes from a performance-only strategy and give the extra to the charity of your choice.
My approach is to consider ESG fund to fulfill major asset classes to complement non-ESG themed funds for that role. Let the participants have the choice as long as ESG fund adequately meets all investment criteria.
Thanks to everyone who participated in our weekly NAPA-Net Reader Poll!
