NEW YORK - The bulk of last week’s newsletter looked at the US Department of Labor’s (DOL) proposal to potentially limit the availability of ESG funds in 401(k) plans (similar to retirement annuities in South Africa), and what really constitutes an ESG fund.
There is good news and bad news here. Part of the good news is that we are not going to debate what is and is not ESG again!
The bad news is that the DOL is reportedly unmoved by the volume of opposition to the idea and will likely press ahead with the proposal.
The good news is that, according to one EGS analyst, the proposal, as worded, does not necessarily spell the end of ESG funds in 401(k) plans.
In a note called ‘US Department of Labor – Slapped by the Invisible Hand,’ Mark Sloss of Regenerative Investment Strategies, sets out a possible safe harbor for ESG funds under the new regime:
It would seem that a ‘blind audition’ process could be instituted where ESG funds could be introduced into plan searches that are conducted as before (based on reasonableness), except the search is agnostic or even blinded to all things non-pecuniary, including ESG, but also considerations like firm size, branding, participant education, and cost sharing.If the ESG option qualifies on the investment merits alone, as the DOL would seem to desire, so be it. That would be a level playing field which would equitably include ESG funds as candidate investments without having to raise the standard so high it upsets the equilibrium of every DC plan covered by ERISA.
Also, on the good news front, it is worth pointing out that maybe none of this matters. As with the DOL’s decision to scrap its fiduciary rule following the change of administration in 2016, whether this new proposal passes or not, it seems unlikely to alter the direction of travel towards investors putting money into ESG funds (or at least funds with ESG labels).
As Josh Brown wrote in 2016 about the move the kneecap the old fiduciary rule:
The genie has been let out of the bottle anyway. Customers have been voting with their feet in the eight years since the financial crisis. They’re rejecting high-cost, low reliability solutions with their dollars. They’re turning their backs on feigned expertise and the sort of institutionalized opacity that has kept them guessing about what they’re actually getting for their money all these years.
And so it is with the move to invest along ESG lines. The flows show momentum is only going one way. Asset managers are demanding greater accountability on ESG issues from the firms they invest in, and in turn are having these same questions asked of themselves to ensure they practice what they increasingly preach.
And it’s not just niche firms asking these questions anymore, as can be seen in this week’s news that Merrill Lynch will be quizzing PMs on its platform about their diversity and inclusion efforts and will be expecting year-on-year improvements. This is for both new and existing managers.
The firm’s top gatekeeper Anna Snider told Citywire:
‘It’s very similar to our expectations around managers underperforming. If you’re underperforming because of stock selection, every time we come together we want to see you not underperforming, or we want to see you progress and have you describe to us how you think you’re going to do that.’
With more than $2tn in assets under management and increasingly limited shelf space, there is no doubt managers want to be on board with Merrill.
And, again casting our minds back to 2016, where Merrill goes others are likely to follow, a view shared by Snider.
‘If it doesn’t come from within, then it will definitely come from without,’ she said.