The signal may be as important as the substance. New guidance from the Department of Labor gives a green light to pension fund managers to consider environmental and social benefits in their investment decisions.
Proponents of the change have been looking for that signal to unlock billions, or even trillions, of dollars for investment in strategies that create jobs, save energy, rebuild infrastructure and restore degraded ecosystems. After all, a similar ruling by federal regulators in 1979 helped unleash the technology revolution by freeing pension funds to make investments in venture capital funds.
“As a society, we’ve only begun to see the potential of impact investing to unleash economic, social and environmental benefits,” said Darren Walker, president of the Ford Foundation and chair of the National Advisory Board on Impact Investing, which has been pushing for the change. He called the new guidance “an important step toward realizing this promise and using the power of markets to help solve some of our most urgent social problems.”
All Things Being Equal
The substance of the new bulletin simply clarifies that pension fund managers are allowed to consider investments that generate collateral benefits to communities or the environment. Such “economically targeted investments” must not sacrifice financial returns or impose greater risks on pensioners themselves, but investment managers can treat social benefits as “tie-breakers” in comparing investments with similar risks and returns.
Perhaps more importantly, the Department of Labor blessed the emerging understanding that the “fiduciary duty” of investment managers to consider environmental, social and governance issues when they are material to the value of the investment itself.
“In these instances, such issues are not merely collateral considerations or tie-breakers, but rather are proper components of the fiduciary’s primary analysis of the economic merits of competing investment choices,” according to the Labor Department’s background analysis of the new guidance.
The new guidance restores 1994 rules issued by the Clinton administration that were effectively reversed in 2008 when the Bush administration said fiduciaries “may never subordinate the economic interests of the plan to unrelated objectives.” Forward-thinking pension fund managers have argued that even the Bush-era rules didn’t preclude them from exercising their “duty of care” in considering long-term financial sustainability and comprehensive risk analyses. But Labor Secretary Tom Perez felt the need to remove any lingering excuses.
“Whatever the stated goal of the 2008 change, a range of stakeholders have told us that, in practice, it has had a chilling effect on economically targeted investing,” Perez wrote in the Huffington Post. “Today, we finally catch up to the breathtaking change we’ve seen in this space over the last few decades. By restoring the 1994 guidance, we bring ERISA investors together with economically targeted investment opportunities -− allowing the capital to meet the opportunity, allowing the money to meet the marketplace.”
That potential can only be realized through investable opportunities that meet pension fund managers’ need for scale, risk-reduction and, of course, returns. To date, only a handful of sustainable investment strategies have attracted significant pension fund investments.
“The new guidance lays down a challenge to create strategies and products that drive real economic value by generating substantial social and environmental benefits,” said Dave Chen, CEO of Equilibrium Capital in Portland, Ore., which counts pension funds as investors in its $250 million ACM Permanent Crop Fund. “These are not tradeoffs, but rather huge opportunities”
Though the guidance technically applies only to managers of pension plans regulated under the 1974 Employee Retirement Income Security Act, or ERISA, the new guidance is likely to set national standards for the definition of ‘fiduciary duty.’
“This decision will have a halo effect as much as the previous standard did,” Audrey Choi, CEO of the Morgan Stanley Institute for Sustainable Investing, told ImpactAlpha. “This will have a halo effect not only on plans directly affected, but on others who are advising and counseling.”
“We think it’s great for individual investors,” she said. “We see the strong growth of interest by individuals in sustainable investment. As plan participants, they can now express their views.”
That so-called ESG (for environmental, social and governance) risk factors are material to investors may seem obvious given events such as the $18.7 billion fines paid by BP after the 2010 Gulf oil spill, or the mounting natural disaster damages with likely links to the changing climate. Even the opportunities to invest in areas such as renewable energy, sustainable agriculture and “green” infrastructure are becoming better-understood by pension and sovereign wealth funds, endowments and other institutional and individual investors.
For example, CalPERS, the nearly $300 billion California Public Employees Retirement System last year adopted new investment principles to nudge portfolio managers to account not only for technical market factors, but broad societal risks such as resource-availability. “A long-time investment horizon is a responsibility and an advantage,” CalPERS declared.
The new guidance “clearly signals that ERISA-governed plans, and by extension, those plans influenced by ERISA, may integrate critical environmental, social and governance issues into their investment decisions,” said Lisa Woll, CEO of US SIF, which tracks socially responsible investments.
Matthew W. Patsky, CEO of Trillium Asset Management, an investment management firm with $2.2 billion in assets, went even further. “We know that integrating environmental, social, and governance factors into the investment process can help identify companies best positioned to deliver strong long-term performance.”