ESG investing entered the political arena in 2020, when stakeholders – threatened by a financial retreat from fossil fuels – lobbied the Texas government to ban ESG investing from employee-sponsored retirement accounts, also known as Employee Retirement Income Security Act (ERISA) funds. States, including Georgia, Arizona, Utah and Ohio quickly followed suit. See our previous analysis here: ESG Backlash: in search of credibility and impact
Proponents of ESG cite better performance among ESG funds. MSCI finds that companies with ESG scores performed better across multiple financial criteria and research from the NYU Stern School of Business supports this claim. ESG allows investors to operate with more information, with insight into how a company is mitigating and adapting to climate change or investing in its people. As a result, ESG is embraced by major financial instructions, including BlackRock, JP Morgan, Morgan Stanley, Goldman Sacks and Wells Fargo. There are $2.8 Trillion of assets under management circulating the US economy, with five-year projections of over $30 trillion.
In March, the fight against ESG took to the national stage. Biden used his first veto to affirm an earlier rule that allows retirement funds to consider ESG issues in their investment decisions – importantly, it does not require them to do so, and many do not; the rule ensures simply that consumers can access funds that do consider those factors if they choose to.
So, what does the Biden rule mean for ESG investments?
As has always been the case, ERISA fiduciaries must maintain a focus on financial returns. However, this decision enables fund managers to incorporate elements of ESG – such as climate change impacts, labor practices or executive compensation – into investment decisions. Employees can also request that their portfolios reflect ESG priorities, as long as their preferences align with the fiduciary duty to avoid knowingly “unwise” investment decisions. The bill also allows ESG to be integrated into automated 401-K plans, in which an employee opts in and the fiduciary selects fund holdings. The decision also allows fiduciaries to use ESG criteria as a tiebreaker between financially identical investments.
Biden’s new ruling clearly creates a more enabling environment for ESG. But companies may still be apprehensive about the state-level backlash. Rest assured; financial institutions haven’t flinched. While BlackRock lost $4 billion USD from the political backlash, its profits topped $230 billion. And several other states, including Illinois, Maryland, New York and Massachusetts have implemented policies supporting the inclusion of ESG in retirement plans.
While the political battle paints ESG as divisive, for savvy investors, ESG risks are impossible to ignore. Deputy Director of the White House National Economic Council may have said it best: “[To ban ESG] You would have to pretend it’s not there, in the same way that the captain of the Titanic would have to ignore the iceberg had he seen it.”