Last week, the Labor Department proposed a new rule that
would make it easier for employers to offer investments in workplace retirement
plans — such as 401(k)s and 403(b)s — that take environmental, social and
governance factors into account.
So-called ESG funds have increased significantly in
popularity over the past few years as a growing base of consumers opt for
investments that align with their personal values. But while the funds are easy
to find in an individual retirement account or brokerage account, they are
currently rarities in 401(k)s.
There are a couple of reasons for that. For one, under
federal law, 401(k) providers must act solely in the interest of the plan’s
participants. ESG funds are still relatively new, so providers did not know for
certain if picking them as an investment option would mean sacrificing returns
or taking on more risk compared with an alternate investment choice, like an
index fund that tracks the full S&P 500.
In recent years, though, more research has come out about
the performance of ESG funds, showing that investors aren’t necessarily
forgoing returns. In fact, the Biden administration’s new proposal indicates
that ESG factors, particularly the economic consequences of climate change, are
actually beneficial for retirement portfolios because they help mitigate
″[C]limate change is already imposing significant economic
consequences on a wide variety of businesses as more extreme weather damages
physical assets, disrupts productivity and supply chains, and forces
adjustments to operations,” the Labor Department said. Companies that aren’t
reliant on fossil fuels, for example, are positioned to perform better in the
future, and thus are superior long-term investments than those that do, the
A second reason ESG funds are rare is because the former
Trump administration was firmly anti-ESG. While it didn’t ban workplace
retirement providers from offering ESG funds outright, it did institute a rule
requiring 401(k) plans and pension funds to make investment decisions based
solely on “pecuniary,” or economic, factors rather than any other
considerations, which made providers hesitant to incorporate ESG into their
evaluations. The Biden administration is walking back those restrictions.
Basically, it’s a win for retirement investors who believe
that ESG factors, like climate change or a firm’s record on gender and racial
equality, make a difference in an investment’s long-term outlook, says Aron
Szapiro, head of policy research for Morningstar, an investment research firm.
He also says that while one criticism of ESG funds is that
they can be more expensive than a typical index fund, the fees have been
dropping and will continue to do so, particularly for 401(k) offerings.
The new rule still needs to be finalized, but when it is,
plan providers will start to offer funds that take ESG factors into account.
Szapiro expects that to happen sometime next year. Those funds would be allowed
to become the default investment option in 401(k)s.
“This is a big step, and it’s good news for investors,” says
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