Interest in sustainable investing is soaring, as more people become convinced that making a positive impact can be profitable as well as good for the planet and society. Unfortunately, the Labor Department doesn’t think these investments belong in your 401(k).
In June, the federal regulator proposed a rule that would restrict workplace retirement plans from investments that include environmental, social and governance considerations. Popularly known as ESG or socially responsible investing, this approach considers the sustainability of a company’s business practices.
The Labor Department said only returns, not business practices, should matter. But its proposal is unusual for a number of reasons, including its wide range of opponents. The rule has been denounced by some of the world’s largest investment managers. The American Bankers Association and the Investment Company Institute, among other business interests, warned the rule could raise costs.
The proposed rule might have made sense 20 years ago, when so-called “socially responsible” investing consisted of a handful of funds that excluded entire industries for social, political or religious reasons and sometimes sacrificed returns in the process.
But “socially responsible” has evolved in to “sustainable” investing and has spread rapidly.
Investment managers haven’t become softheaded do-gooders. They believe, with good evidence, that they will get better risk-adjusted returns if they consider a company’s effect on the environment, potential labor and product liability issues, executive compensation, and the effectiveness and diversity of its board of directors, among other factors.
Sustainable funds have outperformed conventional funds for the past few years and weathered the downturn earlier this year with fewer losses, the research firm Morningstar found.
Screening out investments that use sustainability criteria would be an added expense that regulators don’t seem to have considered, said Aron Szapiro, director of policy research at Morningstar.
“They say, ‘Well, we don’t think it’s gonna cost anything because we think plan sponsors simply won’t use ESG funds,’ but that requires identifying which ones are and are not,” Szapiro said.
“That’s a really big issue with cost that is simply not addressed.”
Another problem was the proposal’s short comment period, which may indicate the department plans to implement the rule, despite overwhelmingly negative feedback.
If enacted, the rule may stymie the growth of sustainable investing strategies in retirement plans that the department regulates, which include 401(k)s and other defined contribution plans as well as most traditional corporate pensions. The rule won’t apply to public pensions, however, or to investments in individual accounts, including IRAs.
You also can invest in ESG funds if your 401(k) offers a “brokerage window,” which lets you invest outside of the plan’s normal investment lineup. You can research options using the Forum for Sustainable and Responsible Investment or an online broker’s mutual fund screening tools. In addition, some automated investment platforms — known as robo-advisers — offer ESG options.
It obviously would be easier if your 401(k) plan would do the screening and offer vetted options. As long as the Labor Department seems determined to prevent that, you will need to put in some work for a shot at better returns.