The US Department of Labor in June issued a new rule related to the use of ESG factors by pension funds in their investing process. As reported in the Financial Times of 1 August, this new rule would require the fund managers “prove that they were not sacrificing financial returns by putting money in ESG-focused investments.” The stated intent of the Department of Labor is to protect investment returns for the ultimate beneficiary – the pension holder. This rule illustrates the difficulty in creating new paradigms in the investment world. It would be just as sensible for the Department of Labor to issue a rule that required investment firms to prove they were not sacrificing financial returns by NOT looking at ESG factors. That of course has not been the status quo but research increasing shows that ESG factors, properly evaluated, can provide better investment decisions.
Cyrus Taraporevala, CEO of State Street Global Advisors reacted quickly with a solidly written commentary in the Financial Times. He stated: “We at State Street agree with regulators that managers investing assets on behalf of pension plans covered by Erisa, the US private pension law, have a fiduciary duty to maximise the probability of attractive long-term returns. That means considering the range of all risks and opportunities that have a material effect on returns.” He goes on to provide further evidence that ESG factors are an important part of any long term investment process.
At the same time the need for quality in ESG reporting and analysis can not be underemphasised. All investment managers must be able to have good information that reflects truth – and not social or environmental whitewashing of the facts. Sarah O’Connor in the Financial Times highlights a case where an apparent strong performer on ESG issues turned out to be less solid than thought. She notes that relying on rating agencies for assessing ESG factors can not substitute for solid research by the investment manager.
Clearly ESG driven investment management is the future. Rules to make it more difficult only preserve the errors of the past. But smart investors also need to do their own due diligence.
