As you may recall, in April the US Department of Labor (DOL) issued a bulletin reiterating its longtime stance that fiduciaries of plans subject to the Employee Retirement Income Security Act of 1974 (ERISA) must not, in the DOL’s words, “sacrifice investment return or take on additional investment risk as a means of using plan investments to promote collateral social policy goals.” Since then media headlines have left many investors, ERISA plan sponsors, and financial advisors with the impression that the DOL has somehow shifted its views on the subject of socially responsible investing—with many concluding that whereas the DOL may have once been more encouraging regarding the consideration of environmental, social, and governance (ESG) issues, it was now openly dissuading sponsors from using these criteria.
We disagree. We believe the DOL’s position has been consistent over time and that the bulletin is simply a commonsense reminder that an investment’s ESG characteristics alone tell you little about whether the investment is prudent—a determination that requires wider context and analysis. Just as important, the bulletin reveals the conundrum at the heart of ESG investing: How does it differ from any other type of investing?
ESG and SRI: Is there actually a difference?
Some like to define ESG investing as the pursuit of better returns via the consideration of ESG issues and contrast it from socially responsible investing (SRI), which was historically motivated by ethical concerns even if that meant precluding potentially attractive investment opportunities. So, for example, an SRI investor might avoid tobacco companies out of concern for the harm their products cause to consumers. An ESG investor, on the other hand, might avoid tobacco companies out of concern that demand for their products was falling. The two investors could end up in the same position—without any tobacco stocks in their portfolios—but their reasoning for how they got there would differ.
Now let’s say demand for tobacco products rebounds or the stock prices fall to the point that the companies become an attractive return opportunity (per the investor’s usual valuation process). If ESG investors buy these companies due to their return potential, then what makes them any different from non-ESG investors? And if ESG investors decline to buy these companies due to their involvement with tobacco, then what makes them any different from ethically motivated SRI investors?
In other words, simply knowing that a company is involved with the tobacco industry in some way isn’t in itself enough information to go on. It’s no easy thing to tell when the right time is to buy a tobacco producer (and it could be never), but the DOL is simply making clear that the determination requires wider context and analysis than simply looking at a single ESG characteristic. For investors who understand this, the updated guidance doesn’t change anything.
The bottom line
The DOL has consistently maintained that plan fiduciaries should consider ESG issues only to the extent that they can argue that those issues directly affect the investment’s economic value. Categorizing an issue as “ESG” doesn’t automatically make it irrelevant to financial performance. Nor does it automatically render it relevant.
Parametric doesn’t believe a portfolio that’s tailored to an investor’s ethical principles and that includes non–financially motivated constraints necessarily performs worse than one that doesn’t. And, of course, both SRI and ESG investors may choose to own and engage with companies that fall short of expectations, rather than avoid them. But an ethically based portfolio won’t necessarily perform better either. And that appears to be the case that fiduciaries operating under DOL guidance must be prepared to make.
Potential Parametric solution
For more than 15 years, we’ve been offering a robust and continually evolving menu of ESG screens and licensed indexes, giving investors a wide range of portfolio design choices. These include a series of risk-controlled, index-like exposures that can be used as a core equity portfolio allocation while aligning with common responsible-investing themes.
Jennifer Sireklove, CFA, Managing Director, Investment Strategy
Jennifer leads the Investment Strategy Team at Parametric, which is responsible for all aspects of Parametric’s equity-based investment strategies. In addition, she has direct investment responsibility for Parametric’s Emerging Markets and International Equity strategies and chairs Parametric’s Stewardship Committee. Previously she helped build Parametric’s active ownership and custom ESG portfolio construction practices. Prior to joining Parametric in 2013, she worked in equity research, primarily covering the energy, utility, and industrial sectors at firms including D.A. Davidson and McAdams Wright Ragen. Jennifer earned an MBA in finance and accounting from the University of Chicago and a BA in economics from Reed College. A CFA charterholder since 2006, Jennifer is a member of the CFA Society of Seattle.
The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Parametric and its affiliates disclaim any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Parametric are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Parametric strategy. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Past performance is no guarantee of future results. All investments are subject to the risk of loss.