The Trump administration has proposed a bill prohibiting pension funds from incorporating ESG criteria into their portfolios.
The Department of Labor’s proposal instructs pension funds to choose investments ‘based solely on financial considerations’. Labor Secretary Eugene Scalia wrote in an op-ed in the Wall Street Journal that standards for ESG investing “are often unclear and sometimes contradictory” and often try to promote a social or political outcome.
‘ESG factors often are touted for reasons that are nonpecuniary—to address social welfare more broadly, rather than maximize returns,’ he wrote. Therefore, Scalia wants pension funds to demonstrate that they have made ESG-oriented investments based purely on ‘objective risk/return criteria’.
The proposed rule “reminds plan providers that it is unlawful to sacrifice returns, or accept additional risk, through investments intended to promote a social or political end,” Scalia added.
Aron Szapiro, Morningstar’s global head of research, said the proposed guideline should be seen in the light of the Trump administration’s scepticism about SRI/ESG. The proposed bill does not prohibit SRI, but requires that a pension plan cannot choose a SRI/ESG investment as a default option. According to Morningstar, this would lead to significantly lower investments in ESG/SRI as the vast majority of clients leave their default options unchanged.
Step backwards
The timing of the bill, which can still be publicly responded to until the end of this month, is unfortunate for the Trump administration. The already strong evidence that ESG criteria can lead to better risk-adjusted returns was only strengthened further during the coronavirus pandemic, when companies with high ESG scores were beating the market.
Recently, Bank of America released a study stating that companies with a high ESG score have lower volatility for their future profits. This is especially true for companies in the energy, materials, utilities and communications sectors.
The United Nations PRI platform, signed by 2300 professional investors around the world, rejected the US government’s proposal. PRI’s CEO Fiona Reynolds called the proposal a ‘significant step backward on responsible investing’.
Joe Keef, president of sustainable investment boutique Impax Asset Management, complained to Barron’s that the new rule ignored the ‘substantial body of research underscoring the materiality of ESG considerations at both company behavior and investment portfolio behavior’.