US regulators wrong to dismiss ESG investing for pensions

The writer is president and chief executive officer of State Street Global Advisors

US regulators are making a mistake that will undermine the long-term financial interests of millions of Americans saving for retirement. The Department of Labor’s proposed new rule discouraging pension plans from considering environmental, social and governance issues when choosing investments misunderstands what matters to performance and should be withdrawn.

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.

It is important to distinguish between “values-driven investing”, strategies aligned with an investor’s own environmental, social and governance preferences, which prioritise impact over returns; and “value-driven” investing that incorporates material ESG factors alongside other traditional financial metrics while still seeking to maximise returns. We agree with the DoL, which supervises Erisa plans, that managers must not use pension plan assets to advance objectives that conflict with that financial imperative.

A growing body of research, however, demonstrates that the so-called “pecuniary factors”, which investment managers are meant to be focusing on, do include material ESG issues. Moreover, ESG issues are growing in significance, as structural shifts in economies and business models driven by technology are elevating the value companies derive from intangible assets, such as brand value and employee engagement.

Traditional financial accounting is becoming less complete for investment decision-making, as knowledge-based companies leverage technology and talent as major sources of competitive advantage rather than the tangible assets of old-style manufacturing.

It is hard to argue that investors should ignore companies’ governance or their exposure to non-linear risks, such as climate change. Now Covid-19 has reinforced our view that social characteristics are a proxy for resilience. Research using State Street data shows that the stocks of companies with strong ESG characteristics, such as good employee safety practices, effective supply chains and agile operations able to repurpose products to meet new market needs, suffered lower declines during the March equity sell-off than the shares of competitors with comparatively weaker ESG characteristics.

Pension plan participants have long investment time horizons, so the DoL should welcome ESG as an effective framework for promoting a long-term investment focus on value creation in a world that is often overly concerned with the short term alone. 

We must resolve the grey areas between material and non-material ESG issues. Policymakers, portfolio managers, pension plan sponsors, researchers and standard-setters, like the CFA Institute, need to work with the Sustainability Accounting Standards Board and the global Task Force on Climate-related Financial Disclosures to help develop better metrics, methodologies and reporting standards for ESG issues.

Researchers are already making progress on ways to help investors better measure the financial impact of intangible ESG value drivers, such as human capital development. Improving the quality, consistency and comparability of ESG information is in everyone’s interest, and will clarify the relationship to financial materiality.

In an uncertain world in which ESG matters more, not less, to strong corporate resilience and sustainable performance, promoting material ESG considerations in investment decision-making is good for the long-term retirement security of millions of American savers.


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