BLK BlackRock Inc

By Dieter Holger 

Investors looking for more sustainable-investing funds in their retirement plans could be in for a wait.

The U.S. Labor Department in June proposed a rule that would make it more difficult for funds focused on so-called do-good investments -- meaning they select securities based on environmental, social and governance (ESG) factors -- to be included in 401(k) plans. The department says the rule, which could take effect as early as Jan. 1, is needed to protect workers from investments that aren't in their best financial interests.

The rule would require retirement-plan providers to choose investment products based solely on financial considerations to avoid "inappropriate investments that sacrifice investment return, increase costs or assume additional investment risk to promote non-pecuniary benefits or objectives." In the "rare" case an ESG investment is "economically indistinguishable" from a non-ESG investment, the plan provider would have to explain why the ESG selection is in the financial interests of the client, according to the proposal.

In 2018, only 2.8% of 401(k)s offered an ESG fund in their lineups, according to the American Retirement Association's Plan Sponsor Council of America, a trade group. Considering many Americans do most of their investing through their 401(k)s, that could help explain why sustainable investing still accounts for just a fraction of overall U.S. fund assets despite dozens of surveys that suggest investors want such options.

Even as dedicated ESG funds remain sparse in 401(k) lineups, some investment pros say ESG investing has subtly gained ground in retirement plans as more workers look to ESG data to inform their investment choices.

"It is making its way more through a side door," says Chris McKnett, co-head of sustainable investing at Wells Fargo Asset Management, pointing to funds that don't identify specifically as ESG but claim to at least consider ESG factors when picking stocks or other investments.

Last year, 564 funds listed ESG as a consideration in their prospectuses, up from just two in 2016, according to Morningstar. Research firm Opimas, meanwhile, says assets under management in North American funds that leverage ESG data swelled to some $17.7 trillion this year from $9.8 trillion in 2016.

Lawyers say any fund that claims to even consider ESG data as part of its investment process could get caught up in the proposed Labor Department rule, as could the few dedicated ESG funds already offered in retirement plans.

There is "no grandfather rule exempting funds already in a plan," says Kurt Lawson, partner at global law firm Hogan Lovells, though the government "might give in to pressure and grant one."

Non-ESG funds, meanwhile, might have to drop any claim that sustainability is part of their investment process if they want to avoid the extra scrutiny, says Vadim Avdeychik, a lawyer at Paul Hastings LLP.

Many of those who expressed opposition to the Labor Department's proposed rule during the 30-day public comment period argued that it singles out ESG investments unfairly for heightened scrutiny, unnecessarily burdens investment firms and is based on a flawed idea that ESG sacrifices returns , according to an analysis by trade group US SIF: The Forum for Sustainable and Responsible Investment and other organizations. The report found that 95% of 8,737 comments opposed the rule.

"The proposal creates an overly prescriptive and burdensome standard," BlackRock Inc., the world's largest money manager, said in its comment to the department. "We find that ESG has much in common with existing quality metrics, such as strong balance sheets, suggesting that ESG-friendly portfolios could be more resilient in downturns."

In response, a Labor Department spokesman says, "The department is carefully considering all the thoughtful comments it received on the proposed rule," which he said will help in "crafting the best possible path forward."

Some 37% of investors in a Wells Fargo survey released in April indicated that one of the top reasons they haven't gotten involved in sustainable investing is because there are no sustainable funds in their 401(k) plans or their adviser hasn't offered them one.

"It does appear on its face a supply-and-demand mismatch," says Mr. McKnett.

Brent Black, a 35-year old engineer in Columbus, Ohio, says having no sustainable funds in his 401(k) is a big hurdle for him.

"I like the idea of being able to invest in a corporation that takes these things very seriously," says Mr. Black, whose latest 401(k) is managed by T. Rowe Price Group Inc. But "most of the money that I am investing on a yearly basis can't be invested in any sustainable funds."

A spokesman for Baltimore-based T. Rowe Price says that ESG is used across the firm's strategies and that it plans to expand its lineup of sustainable funds.

Whether ESG funds are overperforming or underperforming as a category has been a matter of debate in recent years, mainly because there is no one definition of what makes a fund an ESG fund. Still, The Wall Street Journal reported in May that 70% of ESG funds across all asset classes performed better than their traditional counterparts during the first four months of the year, buoyed by investments in big tech and the fact that they have less exposure to oil stocks.

"Now is a good opportunity as any to do more" with ESG investing, says James De Silva, a 37-year-old software engineer in the Detroit area. Despite ESG funds sometimes charging higher fees, he says investing through his 401(k) "is an easier sell" because of the employee match.

Fidelity Investments, the largest provider of 401(k) plans in the U.S., is among the big wealth managers that say demand for sustainable investments isn't going away.

As of December 2019, 16% of the 401(k) plans Fidelity manages offered an ESG fund in their lineups, up 15% from 2018, and 5.6% of plan participants held the funds, the company says. Still, overall assets in these funds remained low at 1.1% of total investments.

"Our plan sponsors have recognized this growing preference among their workers, and some have responded by making ESG funds available," says Christopher Herman, head of investment strategists, workplace investing, at Fidelity.

He says that the Labor Department's proposal "lacks clear definition" for what money managers should consider and that Fidelity has requested changes for a more straightforward explanation.

"The proposal will not achieve the department's goal to provide clarity, " Mr. Herman says.

Mr. Holger is an ETF/ESG markets reporter for Dow Jones Newswires in Barcelona. Email him at dieter.holger@dowjones.com.

(END) Dow Jones Newswires

October 04, 2020 20:48 ET (00:48 GMT)

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