Labor Department clears path for 401(k) plans to offer ESG funds

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More retirement savers may soon have the option of investing in funds based on environmental, social and governance principles, under final rules issued Tuesday by the Labor Department.

The new rule reverses a move by the Trump administration in 2020 that made it harder for 401(k) plans to put ESG investments on the menu. The rule had been in place shortly before President Biden took office, but the administration moved to change it.


Labor Secretary Marty Walsh said, “Today’s rule clarifies that when selecting 401(k) investments and using proxy voting, retirement plan assistants must consider the potential of investing in companies committed to positive environmental, social and governance actions.” Financial benefits can be taken into account.

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ESG funds have grown in popularity in recent years as individuals seek to invest in ways that align with their own values, and to benefit from developments in sectors such as renewable energy.

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Morningstar Inc. Globally, these funds collectively held $2.2 trillion as of September 30, according to Morningstar Direct unit. US Sustainable Funds held $272 billion.

Relatively few 401(k) plans offer ESG investments, partly due to regulatory changes from one administration to the next.

Lisa Gomez, assistant secretary of the Labor Department’s Employee Benefits Security Administration, said regulators have heard from 401(k) plan sponsors and others in the retirement industry that the Trump-era regulation “is a great opportunity to be able to consider climate change and other factors.” There was a chilling effect. ESG factors in decision making about investment proposals.

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The new rule allows employers to consider climate change and other environmental, social and governance impacts when choosing 401(k) investments and exercising shareholder rights such as proxy voting. He added that employers should put the financial interests of employees first and should not sacrifice potential returns for these goals.

Currently, 13% of 401(k) plans offer socially responsible investment options to employees, according to data Vanguard Group publishes on the 401(k) plans it administers.

Industry observers said demand for such investments in 401(k) plans is likely to increase, especially from younger workers.

Several financial services firms have expressed support for the rule and have been offering ESGs so far primarily to investors outside of 401(k) accounts to meet demand. Proponents include the Defined Contribution Institutional Investment Association, a research and advocacy organization for investment managers, advisors and others in the 401(k) industry, which includes Fidelity Investments and BlackRock Inc.

The financial industry charges high fees for ESG funds. According to Morningstar Direct, sustainable funds have an average expense ratio of 0.55% of assets in 2021, compared to 0.39% for traditional peers.

According to Morningstar Direct, ESG funds in the US attracted $9.2 billion in new money in the first three quarters of 2022, down from $39 billion in the first half of 2021.

Ms Gomez said the Biden administration rule would go into effect 60 days after publication in the Federal Register, which should be sooner.

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Proponents of ESG investing say that addressing climate change, improving corporate governance and encouraging diversity boost profits. Critics and some regulators have raised concerns about these claims.

The Securities and Exchange Commission established an enforcement task force last year to pursue cases against public companies or fund managers that misled investors about strategies to hedge climate-change risks.

Republicans have accused investors of trying to force companies to follow a liberal agenda at the expense of the pursuit of profit. in recent months, Florida Govt. Ron DeSantis And other authorities prohibited state pension fund managers from including ESG factors in investments. Proponents of ESG say the data show that socially responsible investments can provide competitive returns.

There is no industry-wide agreement on what holdings an ESG fund should hold.

Some fund managers examine certain sectors, such as oil and gas, and focus on companies at the forefront of sectors such as clean energy. Others try to minimize how much their fund deviates from the broad market by building a portfolio that, for the most part, looks like today’s technology-dominated S&P 500, which is one of the worst ESG practices. taken away from companies.

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Over the past five years, the Morningstar US Sustainability NR Index has delivered an annualized return of 10.15%, or slightly higher than the 10.08% for its non-sustainable counterpart, the Morningstar US Large-Mid Cap NR Index. But over 10 years, the permanent index retreated slightly, according to Morningstar Direct, returning an annualized 12.44% compared to 12.66% for the large-mid cap index.

Labor Department clears path for 401(k) plans to offer ESG funds

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