The Department of Labor has issued a proposed new regulation under ERISA, the federal law that protects workers’ retirement plans. The proposal will actually hurt workers, by penalizing the administrators of retirement plans if they use investment strategies that rely on ESG (environmental, social and governance) principles. It is quite clear that the proposed new rule is motivated by climate denial and a desire to ignore (or perhaps exploit) the growing inequality in our country. The following summarizes the comment we submitted, [along with B Lab US/CAN]. The full text can be found here.
The Department proposed new ERISA rule on ESG investing may interfere with the obligations of retirement plans with respect to “stewardship.” Stewardship includes proxy voting and other ways of changing the behavior of the companies that a retirement plan is invested in. The DOL should encourage such activity by benefit plans because sound social and environmental systems increase the overall financial returns of investors by creating a healthy economy.
1. Diversification and the Importance of Overall Market Return
Sound investing requires diversified portfolios. This principle is reflected in ERISA itself, which requires retirement plans to diversify. The wisdom of a diversified investment strategy can be summarized through the philosophy of the late John Bogle, founder of Vanguard, one of the largest mutual funds companies in the world, “Don’t look for the needle in the haystack; instead, buy the haystack.”
Once a portfolio is diversified, the most important factor determining return will be how the market performs as a whole (“beta”), not how the companies in that portfolio perform relative to other companies (“alpha”). As one work describes this, “[a]ccording to widely accepted research, alpha is about one-tenth as important as beta [and] drives some 91 percent of the average portfolio’s return.” (Lukomnik, et al.)
2. Market return and ESG
This distinction between individual company returns and overall market return is important because shareholder return at an individual company does not reflect “externalized” costs, i.e., those costs it generates but does not pay. In other words, companies let others pay the real costs of harmful emissions, resource depletion, and inequality. Those “others” include other companies that are in the portfolios of diversified shareholders (including retirement plans). Thus, when companies externalize costs, retirement plans suffer the consequences through a lowered return. Shareholders can use stewardship to end this behavior.
A recent study by a major asset manager showed just how serious this problem is. It discerned that 55% of the profits attributed to publicly listed companies globally were consumed by external costs absorbed by the rest of the economy. As the economy absorbs those costs, growth and productivity will fall, leading to decreasing overall market returns. For example, one recent financial analysis shows a 6% increase in global GDP if the world abides by the Paris Agreement. Inequality perpetuated by corporate conduct also has devastating economic (and human) costs as shown in Heather Boushey’s Unbound: How Inequality Constricts Our Economy and What We Can Do about It.
3. The Need for ESG Stewardship
Given the critical importance of overall market return, and the danger to that return from corporate activities the damage social and environmental systems, plan beneficiaries clearly need protection from individual companies that improve their own performance with behaviors that damage overall market return. In order to protect themselves, retirement plans must use their power over corporations to end conduct that exploits common resources.
Because investors collectively have the power to vote against the management, they have the power—and the responsibility—to steward companies away from abusive activities and towards authentically productive profits. A recent report from PRI, a coalition of asset owners and managers representing $89 trillion of assets under management, reaches this conclusion: that collective investor action to manage social and environmental systems is needed in order to satisfy the fiduciary duties of investment trustees.
For all of the reasons expressed above, we propose that the Rule be withdrawn or modified to clarify that ESG actions are not disfavored and that ESG stewardship must be considered by plans in order to fulfill their statutory fiduciary duties. More specifically, we respectfully request that the final rule include assurance that plans will not be penalized for allocating resources to stewardship intended to protect social and environmental systems and to thereby increase the return of the plan on its diversified portfolio.