DoL's proposed ESG ban 'out of step' with advisors: Morningstar

The Department of Labor’s proposed regulatory guidance that would restrict the use of ESG funds in retirement plans is not sitting well with global financial services firm Morningstar.

“Simply stated, the department’s proposed rule is out of step with the best practices asset managers and financial advisors use to integrate ESG considerations into their investment processes and selections,” Morningstar representatives said in a comment letter to the agency, adding that the current proposal “would lead to worse outcomes for plan participants as plan sponsors shied away from assessing ESG risks in selecting investments.”

The department’s proposal would restrict ESG use at a time of rising interest in the topic. In the U.S., mutual funds focused on sustainable investing attracted more than $20 billion in assets last year, more than four-times the flows in 2018, according to Morningstar. The number of ESG considerations in funds grew to more than 500 as of December 2019 from fewer than 50 at the end of 2017. And although not every sustainable fund has been an outperformer, ESG-focused funds have bested their peers over the past one-, three-, and five-year periods.

The department’s proposal is also one of three big changes the agency is plotting for the rules governing retirement funds and investment advice. The Labor Department has moved to expand the availability of private equity in 401(k) plans. It’s also proposed a replacement for the vacated fiduciary rule, which critics charge is too permissive of conflicts of interest.

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The Labor Department’s proposal would require plan sponsors to consider risk-adjusted pecuniary goals when implementing ESG in retirement plans. The agency says it is concerned that the strategies “present economic risks” and “promote environmental, social, and public policy goals unrelated to the interests of plan participants and beneficiaries.”

In response, Morningstar spokespeople write that “ESG risk analysis should be part of any prudent investment analysis — and not called out for special, unique scrutiny. In fact, ERISA fiduciaries should have an obligation to consider ESG risk as it is a pecuniary matter that is fundamental to evaluating the long-term performance of an investment.”

The Labor Department’s proposal includes a 30-day comment period which ends July 30.