Morningstar told the U.S. Department of Labor that its proposed rule on retirement plan investment selection is “out of step” with the best practices that asset managers and financial advisors currently use to integrate environmental, sustainability and corporate governance (ESG) considerations into their plans, according to the fund rating giant’s comment letter.
If the DOL passes the rule as proposed “it would lead to worse outcomes for plan participants as plan sponsors shy away from assessing ESG risks in selecting investments. Indeed, since most participants use qualified default investment options—and ESG considerations would be barred in these options—most participants would not get the benefits that ESG risk analysis can deliver,” Brock Johnson, president of Morningstar Retirement Services, said.
The DOL proposal states that, where investment alternatives are economically indistinguishable, and where the investment selected is based on non-pecuniary ESG factors, fiduciaries should document why the investments are determined to be indistinguishable and why the investment is chosen.
According to Brock, there are no other strategies or kinds of information that the DOL singles out for additional scrutiny the way it proposes to single out evaluating ESG data or strategies informed by this data.
As a result, the proposal would create barriers for considering ESG risks, including those that professional investors managing billions in retirement assets consider to be material. As a result, ERISA fiduciaries would increasingly be out of step with investment professionals who consider material ESG risks, leaving ERISA-covered retirement plans at a disadvantage, Brock said.
Because of the explosive growth of funds that consider ESG in their investment selection, “the line between ESG and non-ESG strategies is increasingly blurry. In this context, the additional scrutiny the department proposes will worsen retirement outcomes as it reduces retirement plan participants’ access to a variety of ESG strategies that are designed to improve investment outcomes by accounting for ESG factors,” Brock said.
“The department’s proposals would put barriers in place for considering ESG risks, including those that professional investors managing billions in retirement assets consider to be material. This will mean that ERISA fiduciaries would increasingly be out of step with investment professionals who will consider material ESG risks when they evaluate risks, leaving participants in ERISA-covered retirement plans at a disadvantage,” he added.
The agency is also out of step with the reality of how mainstream ESG investing has become, the fund rating giant asserted. “We are not unique in embracing these factors, something to which our 3,000 fellow signatories of the Principles for Responsible Investment (PRI), representing more than $100 trillion in assets under management, can attest. Indeed, ESG investing has gone completely mainstream, as evidenced by the rapid growth in sustainable fund flows,” Brock added.
Growth in ESG investments and even conventional funds that factor in ESG issues in a variety of ways—termed ESG consideration funds—has been explosive. In fact, the number of ESG consideration funds grew more than tenfold, from fewer than 50 at the end of 2017 to over 500 as of December 2019, Morningstar said.
Morningstar also believes it is a mistake for DOL to bar plan sponsors from considering ESG risk in qualified default investment alternatives. “The department’s proposal forces participants” to simply hope that ESG risks are being managed and analyzed, instead of permitting a thorough ESG analysis that would develop a view of the long-term sustainability of an investment,” Brock said.
“As is becoming increasingly common among investment professionals, we believe that to holistically assess a company’s long-term prospects, financial analysts need a view into the sustainability of its business, which determines the likelihood that the firm will continue to generate or expand cash flows,” Brock said.
DOL’s proposed rule also represents a sharp break with the agency’s historical approach to enforcing fiduciary standards, Morningstar argued. “DOL has never opined that an approach to evaluating investment risks is better than any other approach, while this rule does just that. Existing law is sufficient to ensure that fiduciaries select investments that are in their participants’ best interest,” he added.