Correcting the Myths On the Labor Department's ESG Rule
The Labor Department is now considering new rules that address whether criteria other than financial opportunity can be used to determine the investment of ERISA funds used for private employee pensions. Specifically, this proposed rule concerns whether private pension funds can invest in social justice-oriented funds, called ESG or “Environment, Social and Governance.” These funds purport to take into account a company’s commitment to the environment, social issues and diversity and equity in governance. Proponents of ESG investing are touting their funds as more resilient during times of economic upheaval and uncertainty but a new study contradicts these claims and suggests that much of the pro-ESG advocacy must be viewed with a skeptical eye.
The government heavily regulates investment opportunities in America. It restricts who can invest in private businesses and sophisticated financial products. We have limits on who can sell investment opportunities and how they can be advertised. Not surprisingly, the proposed rule by the Department of Labor to curb investments that take goals other than financial returns into consideration has vocal opponents. Many of these are financial firms that see the opportunity to sell ESG funds as novel products.
ESG sounds like a good idea, since good people do not want their money invested in unjust activities. However, ESG is really pushed by financial firms eager to sell a new idea, and charge higher fees, and there is no universal criteria for what qualifies a company to be included in an ESG fund. The criteria for ESG are subjective and amorphous, meaning public pensions and public employees are not assured that their investments are actually avoiding unjust activity just because they are placed in ESG funds.
This proposed rule specifically affects ERISA managed private pension funds since the Labor Department has jurisdiction over these entities, but public pension funds should take note since some of the largest public pensions are the most prolific investors in ESG portfolios. The California Public Employees’ Retirement System alone had a market value of $372.6 billion in 2019. CalPERS is an ESG stalwart. In July, CalPERS announced its total return for the 12 months ending June 30th was 4.7%, which is an underperformance compared with a Vanguard Balanced Index fund, which returned 8.2%.
Private pension fund investments account for $10.7 trillion. Because so much money is at stake, there is a lot of rhetoric about this proposed rule. Some of that rhetoric is wrong. Opponents of the rule—those who want to see ERISA funds funneled into ESG funds—have often claimed that ESG funds have outperformed non-ESG funds in the past. This is an attempt to indicate that their future performances would be good. This rhetoric has increased since the coronavirus pandemic. However, the new study from professors in the United States and Europe examined ESG returns since the coronavirus pandemic began and its findings contradict this hype.
According to the study, “Environmental, social, and governance scores have been widely touted as indicators of share price resilience during the COVID-19 humanitarian crisis.” However, “ESG scores offer no such positive explanatory power for returns during COVID-19.” In fact, the study found that ESG failed to protect against, “declining share prices in times of crisis” and that traditional indicators such as profitability, debt levels and liquidity provide much better indications of a firm’s ability to provide value to shareholders during a crisis. The study also warns investors that “ESG investments are at best wasteful and probably even harmful to shareholders.”
Other claims by ESG proponents are even easier to refute. The Forum for Sustainable and Responsible Investment recently issued a report opposing the Department of Labor’s rule claiming that the regulation, “drew 8,737 comments during the brief comment period, including several petition letters signed by thousands of individuals. More than 95% of the comments opposed the rule.” However, the Department of Labor website lists only 1,100 individual comments overall. The rest of the report’s alleged “comments” are merely names of people who signed onto mass form letters and petitions. It is disingenuous to conflate substantive individual comments and mass petitions and claim there was overwhelming opposition to the rule.
In fact, there are very real reasons that the Department of Labor should prevent pension funds from risking their members’ retirements on ESG. ESG funds necessarily exclude important investment opportunities from companies that choose not to submit additional information to be judged by a fund’s ESG standards. Because a smaller set of companies are willing to divulge more information than legally required, ESG funds display less diversification. This increases the risks.
The stakes around this rule are high. It may impact the investment of over $10.7 trillion Of course, the purveyors of ESG will sell their side, but the numbers and prudence that pension beneficiaries deserve requires caution and greater clarity from the Department of Labor.
