ESG Investing: Excellent, Satisfactory, Good?

Retirement plan investment strategies can now include ESG investing considerations.

ESG investing is in the news. A political kerfuffle over its use in retirement plans has provoked President Biden’s first veto.

ESG investing refers to strategies based at least in part on factors in one or more of three broad areas: environmental, social and governance. Investors may consider how well a company handles environmental issues such as climate change, energy efficiency, and natural resource conservation. Social factors may include fair labor practices, product safety, and community relations. Shareholder rights, executive compensation, and transparency would fall under the governance umbrella.

A desire to align investments with personal values and beliefs is a motivating force behind ESG investing. Yet these factors can also be used to measure how well a company manages risks and opportunities in these areas. The effectiveness of ESG as a component of investment strategy has been studied extensively. A major review of these studies concluded that ESG has a positive impact on corporate financial performance. In short, ESG investing can be a sound investment tool.

Yet many conservative commentators and politicians see ESG investing as a way to promote progressive goals. The Trump administration in 2020 issued rules restricting the use of these principles in pension plan investments. Under Joe Biden, the Department of Labor removed that restriction. Republicans objected. Joined by one Democrat in the House and two in the Senate, they voted to block the new regulation. A Biden veto will keep the regulation in force.

The Wall Street Journal groused that the rule represents “the political exploitation of American retirement savings.” Yet the rule merely permits fiduciaries to consider the economic effects of ESG criteria in making investment decisions. It retains the core principle that the duties of prudence and loyalty require retirement plan fiduciaries to focus on relevant risk-return factors.

In any event, there is no denying that ESG investing has broad appeal. Aware of this, companies compete to improve their ESG ratings. Investment firms offer mutual funds built on these strategies, and screening tools their investors can use to build their own strategies. Like it or not, ESG investing is here to stay.