A Battle for the Heart of ESG

How Leaving the Paris Climate Accord is Impacting Your Retirement Options

Photo from December 2015, the Eiffel Tower in Paris lit up with the slogan “Action Now.” Credit: AP Photo/Michel Euler

On June 23, 2020, the US Department of Labor (US DOL) made a bold proclamation. Namely, a formal accusation against ESG as a sound financial investment when it comes to retirement options.

“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,” said Secretary of Labor Eugene Scalia.

This statement creates a tangent between socially responsible values and profits artificially while counter to recent data about the movement.

Since 2005, Capital Markets firms have been thinking about ESG (Environmental, Social, and Corporate Governance) and how those factors integrate into an assessment of a company’s value as part of an investment portfolio. This idea was put forth in a UN authored paper called “Who Cares Wins.”

The paper was endorsed by the large, global names you recognize such as Morgan Stanley, Goldman Sachs, UBS, and others. In it, the seeds of creating a sustainable society through resilient investments are planted.

Companies that perform better with regard to these issues can increase shareholder value by, for example, properly managing risks, anticipating regulatory action or accessing new markets, while at the same time contributing to the sustainable development of the societies in which they operate. Moreover, these issues can have a strong impact on reputation and brands, an increasingly important part of company value.

In other words, purpose doesn’t come at the expense of profits. It can help you understand risk and where the market is going — things that lead to financial prosperity. Back in 2005, this too was a bold proclamation. It’s not been until recently that we’ve been able to understand the data around ESG investing.

Firms and investors latched on to ESG investing in earnest over the past 5 years. When the pandemic hit, one of the bright spots in the market turned out to be ESG. It seemed the moment for socially responsible investing had arrived. The data is proving out that purpose can meet profit and that investors are eager to put their money into these values.

From Nasdaq, showing ESG has outperformed the S&P 500 by around 3%
Graphic from Nasdaq (ESG has outperformed the S&P 500 by 3% over the last year).

This doesn’t necessarily represent companies that are just looking at one factor. At first glance, ESG appears to be a vehicle to combat climate change, but that’s not necessarily the case with many institutional investors favoring good corporate governance. In one article, Charlie Mahoney and Steffen Bixby carved out just companies with good social governance (via shareholder issues) and got the same 3% result.

Still, Scalia’s opinion persists. This decision would effectively lock out employers from offering retirement vehicles that align with their newfound sense of purpose, but also discourage practices that lead to good fiduciary results. It also represents a vast departure from the US DOL’s 2015 news release regarding the matter:

The guidance also acknowledges that environmental, social, and governance factors may have a direct relationship to the economic and financial value of an investment. When they do, these factors are more than just tiebreakers, but rather are proper components of the fiduciary’s analysis of the economic and financial merits of competing investment choices.

This view more closely aligns with the EU’s Commission action plan on financing sustainable growth, written in 2018, which explicitly calls out the firms to consider these factors.

To clarify institutional investors and asset managers’ duties in order to make sure they consider, in an appropriate manner, environmental, social, and governance (ESG) issues in their investment decision process and are more transparent towards their clients.

Instead of moving the US forward, the current administration has left the Paris Climate Accord and now filed this opinion on ESG. Considering the EU Commission called out the Paris Climate Accord first as the call to action in their action plan, the US DOL’s reversal here makes sense.

The US DOL has returned to a legacy mindset, fixated on the environmental aspect solely in a non-sensical view of ESG where assessing the overall ESG risks drive ‘social goals’ which work against an investment’s profitability.

This opinion has been mind-bogglingly published against the backdrop of the hottest temperature ever recorded in the arctic (environmental), the appropriate and undeniable resurgence of #BlackLivesMatter and the importance of diversity (social), and the recently revealed fraud at Wirecard (corporate governance). It is common sense how the analysis of any of these types of factors could play into an investment strategy.

Another recent US DOL filing around retirement plans could be related to a casting out of ESG. This recent US DOL bulletin opens up the possibility of Private Equity as an investment vehicle for retirement plans. The reason it could be a signal away from ESG is this assessment from an Osler article.

Historically, the private equity industry has often been perceived to have a singular focus on financial returns for investors.

Meaning private equity is focused on the traditional fiduciary return models. The rest of the paragraph, however, shows ESG is making in-roads here.

While that reputation still persists in some circles, the reality is that private equity sponsors have been buying into and adopting various forms of ESG investing policies for more than a decade.

The question becomes, even with the US leaving the Paris Climate Accord and the recent US DOL announcement, can anything stop the market momentum of ESG? At worst, this bulletin strips investors of the right to invest along a risk model that considers relevant factors and, at best, it shows the US DOL’s irrelevance when it comes to setting sound, fiscal policies.

Lastly, I’d like to leave you with the mission of the US DOL, which appears in this filing. If you consider ESG to be a valid source for understanding risk models, you might find this statement to be as ironic as I do.

The mission of the Department of Labor is to foster, promote and develop the welfare of the wage earners, job seekers and retirees of the United States; improve working conditions; advance opportunities for profitable employment; and assure work-related benefits and rights.

The views expressed here are those of the author’s only and does not represent financial advice.