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U.S. President Joe Biden signs executive actions in the Oval Office of the White House on January 28, 2021 in Washington, DC.
Doug Mills-Pool/Getty Images
The Biden administration will start walking back a controversial Department of Labor rule that would curb the use of ESG, or environmental, social, and governance, funds in 401(k) retirement plans, though it may take as long as 18 months to undo it completely, analysts tell Barron’s. ?????
In November, the DOL finalized a rule that made incorporating ESG funds in retirement plans more difficult. The rule, which took effect Jan. 12, requires plan sponsors and other fiduciaries selecting ESG funds “to separate the legitimate use of risk-return factors from inappropriate investments that sacrifice investment return, increase costs, or assume additional investment risk to promote non-pecuniary benefits or objectives.” The final rule doesn’t contain specific references to ESG because there is no uniform definition of the term. Instead, it refers to pecuniary and non-pecuniary factors.
This month, President Joe Biden ordered an immediate review of federal regulations passed in the last four years that conflict with the national objective of confronting the climate crisis. ESG funds prefer companies that avoid environmental risk and that focus on solutions to climate change.
Bryan McGannon, director of policy and programs at US SIF, a nonprofit devoted to promoting sustainable investment, says he expects the DOL “to issue guidance to clarify that ESG criteria is pecuniary under the definition of the rule.” The DOL can do that without the cumbersome notice and comment period.
For that to happen, Biden must appoint an acting director of the Employee Benefits Security Administration, analysts say. A permanent director must be approved by the Senate.
It will take at least 18 months to revise the rule completely so that ESG investment criteria are formally considered pecuniary, or for the language regarding pecuniary and non-pecuniary distinctions to be removed, McGannon says.
Sustainable funds are likely to be popular as retirement-plan options. Net new investment flows into sustainable funds of $51 billion in 2020 were more than double their total for 2019 and nearly 10 times more than in 2018, according to fund tracker
Morningstar.
That accounted for almost a quarter of all stock and bond fund flows last year.
And recently, ESG funds have done well, such that 101 of 161 stock and bond mutual funds and ETFs with sustainable objectives have beaten their category peers in the last five years, according to Morningstar Direct. Some of the largest funds, such as the $23.3 billion
Parnassus Core
(ticker: PRBLX), $13.3 billion
iShares ESG Aware MSCI USA
(ESGU) and $10.8 billion
Vanguard FTSE Social Index
(VFTNX), have done exceptionally well, meriting five stars from Morningstar for their strong risk-adjusted performance and, in the case of Vanguard and iShares, low fees.
For now, the rule has dissuaded plan sponsors from adding ESG funds to their offerings until there’s more clarity on the issue. “The flows into ESG funds last year were huge, interest from investors is higher than ever, and asset managers are using it more than ever,” says Jon Hale, Morningstar’s head of sustainability research. “It would be precisely the time when we would see a lot more particularly defined contribution [401(k)] plans, wanting to or being interested in adding ESG. And this rule is having a clear chilling effect on that.”
That chilling effect includes Morningstar’s own retirement management group, which advises plan sponsors on fund selection, Hale says. “Morningstar is in the same boat as everyone. We don’t as a firm agree with the rule, but it is in effect.”
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