What Should Investors Make of the Department of Labor’s Recent Guidance for Enforcement Staff and Plan Fiduciaries on ESG and Economically Targeted Investments?
An update to a previous advisory from the U.S. government on how fiduciaries and DOL enforcement staff should treat environmental, social and governance (ESG) criteria in investment decisions has led to different interpretations of what it means.
However, it does not change ESG’s growing importance among investors and Plans, or that fiduciaries often have good reason to consider ESG criteria, economically targeted investments (ETIs) and engagement strategies for their Plans.
In April 2018, the U.S. Dept. of Labor (DOL) issued Field Assistance Bulletin (FAB) 2018-01 to clarify DOL direction on ETI and ESG investing, shareholder rights and investment policy statements.
How Can Investors Interpret the DOL’s View on ESG Investment Considerations?
The DOL seems to agree that ESG factors could be additive to investment results, as per a quote from FAB 2018-01:
“…there could be instances when otherwise collateral ESG issues present material business risk or opportunities to companies that company officers and directors need to manage as part of the company’s business plan and that qualified investment professionals would treat as economic considerations under generally accepted investment theories.
“In such situations, these ordinarily collateral issues are themselves appropriate economic considerations, and thus should be considered by a prudent fiduciary along with other relevant economic factors to evaluate the risk and return profiles of alternative investments.
“In other words, in these instances, the factors are more than mere tie-breakers]. To the extent ESG factors, in fact, involve business risks or opportunities that are properly treated as economic considerations themselves in evaluating alternative investments, the weight given to those factors should also be appropriate to the relative level of risk and return involved compared to other relevant economic factors.”
Where the confusion comes in, it seems, is when the DOL goes on to state in the bulletin that:
“Fiduciaries must not too readily treat ESG factors as economically relevant to the particular investment choices at issue when making a decision.
“ It does not ineluctably follow from the fact that an investment promotes ESG factors, or that it arguably promotes positive general market trends or industry growth, that the investment is a prudent choice for retirement or other investors.
“Rather, ERISA fiduciaries must always put first the economic interests of the plan in providing retirement benefits. A fiduciary’s evaluation of the economics of an investment should be focused on financial factors that have a material effect on the return and risk of an investment based on appropriate investment horizons consistent with the plan’s articulated funding and investment objectives.”
It seems that the DOL is stating that while ESG factors may be economically relevant to a particular investment, it should not be assumed that ETIs or ESG investments are the most economically relevant to the plan.
Fiduciaries should fully evaluate the “financial factors that have a material effect on the return and risk of an investment” per their investment horizons and objectives, and ESG can certainly be relevant to that assessment, among other factors.
What does this guidance mean for fiduciaries? There are differing interpretations. Some plan sponsors and investors are unclear if the DOL has changed its views on fiduciary duty as it pertains to responsible investing.
It may be a clarification of the degree to which fiduciaries can include ESG criteria in their evaluation of investments. Others perceive the bulletin as a stylistic shift away from the previous administration’s more substantial guidance without substantive change.
A Field Assistance Bulletin from the DOL is considered to carry less weight than an Interpretive Bulletin, the most recent of which was issued under the previous U.S. Presidential Administration.
Segal Marco Integrates ESG Criteria in Research Process
Segal Marco applies ESG integration in its Seven Principles methodology for assessing asset managers. Full ESG integration represents Segal Marco’s view that ESG is not a segregated consideration but rather is descriptive of factors that may impact performance across asset classes.
Segal Marco serves as a trusted advisor to its clients as they seek to attain their investment goals and objectives. Segal Marco believes that the value or worth of corporate entities in which our clients may invest is materially affected by a large number of factors, both economic and fundamental, including ESG factors.
Segal Marco has adopted a Seven Principles methodology when evaluating and recommending asset managers. Principle IV calls for a consideration of how a manager’s investment process generates and captures the best ideas in its portfolios.
Areas to be evaluated under Principle IV include:
- Defined and transparent objectives and desired output
- Consistent, repeatable, and well documented process
- Logical decision-making sequence, key inputs, and accountability
- Effective portfolio construction methodology/management
- Controlled risk variables
- Continuous improvement mechanism
In order to effectively evaluate these areas, it is incumbent upon Segal Marco to assess each investment manager’s ability to consider and integrate all factors that may materially affect the value or worth, at present and in the future, of all corporate entities in which our clients may invest, including ESG factors.
The way in which asset managers incorporate ESG into their security selection process is, therefore, fully integrated into the Seven Principles methodology.
What is the DOL’s Stance on Shareholder Engagement?
The bulletin restated its guidance on proxy voting and engagement. These are tasks that fiduciaries may utilize as a way of influencing decision-making of companies owned by their Plan. Fiduciaries that participate in proxy voting and engagement do so to enhance shareholder value.
The bulletin acknowledges that fiduciaries should engage in proxy voting, as it is consistent with their duties.
On shareholder engagements, the DOL cautioned that plan fiduciaries should not rack up plan expenses for engagement activities, such as mailing campaigns or proxy fights.
However, in practice, this usually is not a big issue for ERISA fiduciaries. ERISA plans avoid waging proxy fights, calling special meetings or spending significant resources to campaign for a shareholder proposal.
In addition, engagement work undertaken by institutional investors is primarily conducted through broad coalitions, where costs are shared.
Forging Ahead with ESG Investing
The recent DOL bulletin reiterates that plan fiduciaries should thoroughly research appropriate ways to include ESG metrics in their portfolio.
The fact that there has been distinct guidance from the DOL over the last few years seems to confirm the growing interest these investment considerations have generated.
Segal Marco believes asset managers and all fiduciaries should be able to articulate their approach to assessing all material elements that may affect future prices including, but not limited to, statistical measures of value, profitability, balance sheet soundness, as well as material environmental, social, and governance factors and how they apply this information to their strategies.
The recent guidance from the DOL has no impact that diminishes the value of incorporating ESG factors in evaluating investment strategies and for managing plan risks.
In fact FAB 2018-01 most certainly concludes that the economic interests of the plan must come first – based upon this guidance it is inconceivable that material ESG factors affecting those interests should or could be ignored.
Segal Marco Advisors provides consulting advice on asset allocation, investment strategy, manager searches, performance measurement and related issues. The information and opinions herein provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. Segal Marco Advisors’ R2 Blog and the data and analysis herein is intended for general education only and not as investment advice. It is not intended for use as a basis for investment decisions, nor should it be construed as advice designed to meet the needs of any particular investor. Please contact Segal Marco Advisors or another qualified investment professional for advice regarding the evaluation of any specific information, opinion, advice, or other content. Of course, on all matters involving legal interpretations and regulatory issues, investors should consult legal counsel.