“There are a few topics that are more confusing than ESG within the context of retirement plans,” Mary Green, ESG Client Portfolio Manager at Federated Hermes, said on a webinar during the Broadridge Fi360 Solutions Annual Conference 2021. “Fiduciaries have been whipsawed in the last 12 months by DOL rules, proposals and pauses.”
Related: Biden’s DOL Scraps Trump Era ESG Rule
Robert Sitkoff, a professor of law at Harvard Law School, pointed out that the same fiduciary principles that apply to other investments apply to ESG investments. Advisors are used to having specific rules laid out for them, he said, but “some of the difficulty here is that that’s not how fiduciary works.”
ERISA statutes establish a responsibility of loyalty and prudence, and Sitkoff explained that the U.S. Supreme Court ruled in 2014 that the benefit that advisors are expected to act in the best interest of are explicitly financial and does not include nonpecuniary benefits.
However, he added that “cheaper is not the same as prudent. Prudent means you’re weighing the costs and benefits; needless costs, costs that are not justified by benefits, are not prudent,” Sitkoff said.
Sitkoff noted that the final ESG rule that was adopted was much different from the earlier rule that had been proposed. He distilled the approved rule into two bullet points:
- Fiduciaries’ advice must be based on pecuniary factors.
- A “pecuniary factor” is one that the fiduciary has “prudently determined has a material effect on the risk and/or return on investment based on an appropriate investment horizon.”
He pointed out that these standards are the same as anything else that fiduciaries are held to.
Evaluating ESG options
Martin Jarzebowski, Director of Responsible Investing at Federated Hermes, said that the market is starting to show convergence between environmental, social and governance factors.
Related: How Proxy Voting Could Help 401k Participants Meet ESG Priorities
He offered three pillars of ESG investments that fiduciaries need to evaluate in their investment process.
- Integration. Incorporate ESG factors into the investment process as part of a fiduciary’s due diligence.
- Exclusion. Exclusionary products use negative screens and divestment so that returns aren’t from products that are misaligned with an investor’s values.
- Impact. Impact-oriented products are designed to focus on mission. “You really have to look under the hood and understand the portfolio construction of that product” to determine its appropriateness in a portfolio.
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Danielle Andrus works as an editor for The Financial Planning Association® (FPA®). Over the past 15 years, she has worked in various capacities, including writing and editing. Andrus has worked for several notable publications and outlets and spent more than seven years as the executive managing editor at ALM Media, publisher of Investment Advisor magazine and ThinkAdvisor.com. Before that, she was online editor for Summit Professional Networks, where she oversaw newsletter development for four magazines, including Benefits Selling, Senior Market Advisor, Boomer Market Advisor, and Bank Advisor.
