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ESG investment gets a boost as Labor plans to widen 401(k)s to include green-rated assets

PUBLISHED ON 2021-10-14 15:58:00 EST Prathapan Bhaskaran

ESG relationship

Biden administration reverses Trump policies that made it harder for 401(k)s to diversify portfolio

  • Wall Street firms support Labor proposal expanding scope of 401(k)s

The Labor Department’s recent proposal to make it easier for investors to buy funds focused on ESG (environmentally sound, socially responsible, and transparently governed) companies in their 401(k) plans promises boost to responsible investment.

This is particularly important at a time when global communities are starting at climate change and the world population and economy are emerging from the effects of the COVID-19 pandemic. 

ESG funds are becoming increasingly popular as more people want to invest in companies that align with their values regarding the environment, climate change, social responsibility, and administrative and financial transparency.

Lower broker fee

The broker fee on these types of funds is often lower on Wall Street when compared to other asset classes. Sustainable funds charge an average of 0.61% of assets, compared to 0.41% for ESG.

Biden administration’s proposal that will undergo a 60-day comment period before acceptance can reverse a Trump administration rule that made it more difficult for 401(k) plans to invest based on ESG measures.

READ MORE: Why is ESG-rated investment such a hot topic? Does your 401 (k) account allow ESG investment?

“ESG factors can be financially important, and considering them will lead to better long-term risk-adjusted returns,” according to Ali Khawar, acting assistant secretary for the Employee Benefits Security Administration at the Labor Department. The Employee Retirement Income Security Act of 1974 that Labor Department administers manages the retirement plans.

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There are studies showing that socially responsible investments perform better in the long run. The MSCI KLD 400 Social Index has returned an average of 16.88% a year in the past decade, compared with 16.68% for the MSCI USA Investable Market Index, a report in Wall Street Journal said.

ESG-rated investments’ rise has not been without controversy as some have expressed fear that asset managers could mislead investors with wild claims. The possibility of such malpractice will only increase as the general concern over climate change increases.

Flow of new money

An enforcement task force of the Securities and Exchange Commission has been watching out for misleading claims by investment advisors and public companies.

ESG monitoring website Morningstar reports that ESG funds attracted $39 billion of new money in the 2021 first half.

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Vanguard Group’s data on the 401(k) plans it administers show that 12% of funds offer socially responsible investment vehicles to employees.

According to Lew Minsky, the president of 401(k) industry research and advocacy Defined Contribution Institutional Investment Association, the demand for similar investments in 401(k) plans will grow as millennials become more dominant in the workforce and Gen Z starts entering the workforce. Socially responsible funds are likely to become far more competitive than other 401(k) offerings.

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There is still speculation when the proposal will take the shape of a definitive policy initiative. Michael Kreps, a principal at Groom Law Group that specializes in retirement plans and policy, expects the Labor Department proposal to become final in the first half of 2022.

The American Retirement Association that represents retirement-plan professionals supports the proposal. “We are pleased that the DOL has established a level playing field for ESG investment considerations in retirement programs,” the group stated.

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