Are ESG funds for you?
Last year the U.S. Labor Department proposed a regulation that would tell retirement-fund managers to consider ESG factors such as “climate change” and “collateral benefits other than investment returns” when investing employees’ money.
These types of regulations will encourage pension plans to invest in politically correct but unproven ESG Strategies. ESG is short for (environmental, social and governance) funds. These regulations are also in conflict with the fiduciary responsibilities of retirement and pension-fund managers. These managers are legally required to make every investment decision with one purpose – maximizing retirees’ financial interests. There is even a law adopted in 44 states called the Uniformed Prudent Investor Act. The UPIA makes it clear that “no form of so-called ‘social investing’ is lawful if the investment activity entails sacrificing the interest of beneficiaries in favor of the interests supposedly benefitted by pursuing the particular social cause.”
While many people claim “you don’t have to trade values for value. Green can enhance returns,” according to a 2021 quote from Al Gore. That claim hasn’t aged well. ESG funds have trailed the market since the beginning of the year and are badly underperforming the sectors including oil, gas and coal.
What also has become a concern for investors is are they truly getting funds that are invested in companies with a social commitment to the environment, social and governance. Some funds labeled ESG have the same stocks in them that non-ESG funds have. The only notable difference is the management fees. ESG funds tend to have higher management fees, and in some cases can be five times as high. While fund managers claim the added cost is the result of their effort to choose stocks that meet the requirements of ESG, when the results are the same (same stocks) one wonders. In fact the SEC is investing the claims of some funds to see if they truly are ESG funds.
To add to the confusion a major stock index that tracks sustainable investments dropped electric vehicle-maker Tesla from its list in May 2022 but it kept oil giant Exxon Mobil.
ESG funds are also not limited to environmental issues. Promoting diversity and racial equality is part of the goal of ESG funds. While creating a diverse board of directors may seem desirable, it generally has not increased value of a company.
Investing is the act of distributing resources into something to generate income or gain profits. If you choose investments for reason other than income or profit do not be surprised that your income or profit will be reduced.
When a government entity regulates investment decisions to reflect desired social changes the cost is born by those who participate in the retirement plans. Many retirement plans in this country are underfunded. If the government requires investment strategies that will increase cost and reduce returns then the underfunding will only increase.
If your goal to investing is to maximize your return, then ESG funds may not be for you. If you are willing to sacrifice return for a commitment to issues that are important to you, then ESG funds may be the way to go. Just make sure that the ESG funds you choose truly reflect investments in the issues important to you.
As a fiduciary selling investment products, this will be new territory. Additional questions on investment goals may needed to be asked. Simply what is best for the investor may not be the standard. Talk to your professional and see if your investments reflect your goals of investing, and commitment to social issues.
Bob Hollick is a State Farm Insurance agent based in Washington. His column appears every other Friday in the Observer-Reporter.