DOL guidance on ESG funds shouldn't have chilling effect on social impact investments

The latest Department of Labor bulletin said economic performance must trump any potential social impact when judging an investment for retirement accounts

May 3, 2018 @ 4:03 pm

By Jeff Benjamin

Financial advisers looking for an excuse to avoid allocations to investments based on environmental, social and governance factors have been handed a hall pass in the form of a recent bulletin from the Department of Labor.

While the densely-written April 23 field assistance bulletin doesn't technically alter any previous DOL guidance related to the use of ESG funds, it does reiterate that economic performance should be considered ahead of any potential social impact related to investing in the funds.

"What the DOL did was satisfy the people who like to say the world is flat, and it lets the flat-worlders off the hook, but for people who know better, it does nothing," said Bob Smith, CEO and chief investment officer of Sage Advisory, which manages $13 billion, including $700 million in ESG portfolios.

The DOL bulletin, which impacts investment options in company-sponsored retirement plans, has been interpreted by some as politically walking back 2016 guidance issued under then-President Barack H. Obama.

Mr. Smith acknowledges the likelihood of some political gamesmanship, but also agreed that investment performance should always be the priority of a fiduciary.

"They basically said, if you're buying things purely for the virtuous issues of ESG, you're going to have a fiduciary headache; however, if ESG has an economic impact then by all means you're welcome to do that," he said. "It's just getting back to the basics. It's not ESG ahead of financial interest, it's ESG co-equal with financial interest."

In downplaying the DOL announcement as a "lower-level field bulletin," Meg Voorhes, director of research at US SIF, The Forum for Sustainable and Responsible Investment, said she doesn't believe it will have any dampening effect on the growing popularity of ESG investing.

According the most recent research from US SIF, at the end of 2016, $8.72 trillion in assets in the United States qualified as social and impact investing.

That's up from nearly $7 trillion at the end of 2014, and $4 trillion at the end of 2012.

"It's dense and confusing and a little poorly written for lay people to understand, and if you're just starting to look at ESG options, looking at that field bulletin might be a little daunting," Ms. Voorhes added. "But, basically it just reiterates previous bulletins."

One part of the bulletin that stands out as updated guidance, Ms. Voorhes said, relates to using ESG funds as qualified default investment alternatives for investors that have not selected an investment allocation.

"Typically, that default option is set up to be a lifecycle fund," she said. "I don't think anyone was thinking of using ESG for the QDIA."

As the CEO of Private Ocean, a $1.6 billion advisory firm that only started allocating to ESG funds this year, Greg Friedman described the DOL bulletin as a "ridiculous rule."

"It is probably one of the most politically motivated proposals I've ever seen, and the marketplace is not in line with that proposal at all," he said. "If clients feel like they're giving up significant return potential they won't want to go in the ESG direction."

In terms of the possible political motivations behind a memo that mostly reiterates existing guidance, Ms. Voorhes believes it is more likely the byproduct of bureaucrats in action.

"I don't know if it's political or if it's just that you have civil servants who are not all that familiar with ESG investing and how it has developed," she said. "I recall meetings at the beginning of the previous administration, and sometimes there were comments related to ESG investors not caring about returns, which isn't accurate."

Rakhi Kumar, head of ESG investment and asset stewardship at State Street Global Advisors, also shrugged off the notion that the bulletin would put a dark cloud over ESG investments, whether inside or out of retirement plans.

"The bulletin does not exclude the use of ESG investments, it just says the economic data must come first," she said. "We see more interest in ESG integration among investors, and we're not in any way concerned about this putting a damper on ESG investing."

One thing the bulletin will likely do is force advisers to keep precise records to help justify any allocations to ESG investments, according to Sonia Kowal, president of Zevin Asset Management, a $600 million firm that exclusively builds ESG portfolios.

"I think it potentially will be used as an excuse by people that aren't really looking at this stuff and aren't really into it, but I don't think it's that serious, because it confirms that ESG factors can present material investment consideration," she said. "As fiduciaries, we're going to have to document the approach a little more in order to cover ourselves."

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