In this episode of Adam Talks, IRA Financial’s Adam Bergman Esq. explains Environmental, Social, and Governance (ESG) investing and discusses if the government should have a say in what you invest in.

Is ESG Coming for your 401(k) Plan?

Hey everyone, Adam Bergman here, tax attorney and founder of IRA Financial. On today’s podcast, going to be chatting about ESG. What is that? Does the government want the funds your 401(k) will be investing in to be concerned about the environment or other considerations? And it’s an interesting topic, right? And I don’t have the answers, but what I want to do is talk about the DOL Rule in ’21 and talk about what potentially the Biden administration could be doing, and right now it’s actually considering, some regulation that would allow fiduciaries of a 401(k) to permit social environmental considerations when selecting funds for your 401(k).

So, we will discuss that and we’ll then talk about IRAs versus 401(k)s and should the government actually be involved in making investment decisions for your 401(k)? And that’s something we could agree to disagree; I personally do not think so. I think it’s our 401(k). We’re responsible for our investments. We’re responsible for our retirement. We should make our own investment decisions, whether we want to invest in oil, guns, the environment, technology, electric cars, whatever it is, it should be our call, okay? Because ultimately we got to deal with our own retirement.

Yes, Social Security will hopefully be available, but we paid into that system. That’s money that we already paid in that we should are entitled to receive it back. But for the government to come in and tell us that the 401(k) funds that we could select need to potentially consider social environmental considerations, is that a reach? Should they ban 401(k)s from investing in gun companies? Even, what happens if gun manufacturing companies perform better than technology companies? Should we be banned? Should we not be allowed to invest in Shell or other companies that may be in violation of some environmental considerations? Personally, again, I think it should be up to the individual. Maybe I’m too libertarian, but I don’t think it’s government’s place to be telling fiduciaries, 401(k) employers, trustees, how and what should be considerations for investments. Employees should have the opportunity to invest in the best performing funds and we’ll talk about how ESG’s funds have done this year. How do they perform?

So, let’s start with the top. What is ESG investing? So, it’s known as socially responsible investing; impact investing; sustainable investing. Basically, refers to investing which prioritizes optimal environmental, social and governance and that’s, those factors are a paramount concern. It’s a way of investing sustainably where investments are made with consideration of the environment and human well-being as well as the economy. It’s based on the growing assumption that the financial performance of organizations is increasingly affected by our environmental and social factors. I’ll leave it at that.

You know, it’s nice that the government wants us to focus on optimal environmental, social, and governance. We all want a safe environment. We all want a world that has clean water and uses clean energy. But, reality is we don’t want to pay $50 per gallon and until we are at that point where we have sustainable energy sources, whether it’s nuclear or natural, we got to do what we got to do. Whether you agree with me or not, that’s fine. You have the right to invest in socially responsible investing. I just don’t believe that the government should force us to.

So, let’s talk about what is going on in the Hill. So, the DOL, back in October 13, ’21, they released a proposal under the Employee Retirement Security Act (ERISA) to clarify that plan fiduciaries can consider climate change and environmental social governance factors when they make investment decisions and when they exercise shareholders’ rights, including voting on shareholders’ resolutions and board nominations. If finalized, as they are proposed, the regulation can remove certain barriers from ERISA to select ESG investments, so long as those selections are otherwise consistent with the prudent and loyal investment decision process.

Here’s the background. In late 2020, the DOL issued the final rules on financial factors in selecting plan investments, they rule on fiduciary duties regarding proxy voting and shareholder rights. They became effective, as I mentioned, October ’21. Well, they’re not effective; that’s when the DOL released the proposal. And the general view of the asset management industry is that they created uncertainty around whether ESG factors can be considered pecuniary, basically taking priority, and, as a result, whether a fiduciary may consider ESG and other factors in making investments.

So, the DOL rules came out October ’21, but a lot of questions remain. How much weight should these ESG considerations be given? What happens if there’s a tie between two funds, an ESG and a regular fund? Which fund should win? Should the investment returns pecuniary matters impact that decision? It’s unclear at this point. So, they issued non-enforcement statements in March 2021. In May 2021, President Biden issued an executive order on climate-related financial risk directing the DOL to consider publishing a proposed rule to suspend, revise, and rescind the 2020 rules. And the proposed would amend the ’20 rules, okay?

So essentially, the proposal keys was to remove the ESG rules referencing pecuniary factors in the articulation, ERISA’s fiduciary investment responsibility. So, Trump administration basically put these rules in place that said, hey, you need to look at at the end of the day, you got to look at investment returns. If you’re making fund decisions or offering funds to your employees, at the end of the day, the money is what matters. It shouldn’t be ESG. Money trump’s other concerns, and these proposals basically want to take that away, and they basically want to have a clarification of the tiebreaker test and removal of corresponding paperwork.

So, under the proposal, if the fiduciary prudently concludes that competing investments equally serve the financial interests of the plan over the appropriate time horizon, the fiduciary may choose one of the investments based on collateral benefits, like ESG. So, essentially saying, hey, the funds got to be equal. If they’re equal you can use ESG as a tie breaker, but you should still pick the best funds for your employees. And that’s kind of where we’re at. And the idea is that, hey, the Biden administration will likely rescind the Trump error pecuniary test, which basically says, hey, you got to take the best fund for your employees, which kind of makes sense. And Biden is still saying, yeah, that’s important, but if it’s a tie, you can give collateral factors significant weight like ESG.

So how are ESG funds done? Okay, so essentially, I did a little research on this, and this is, this article I found back in July 2022, the funds with a higher rating saw a loss of 13% on average. The ESG funds with a higher rating saw a loss of 13% on average in the period compared to those with lower ESG ratings, which lost 4%, okay? So, the ones with a higher ESG rating that was more focused on environmental/social concerns did worse than the funds with a lower ESG rating.

So, if you look at the highest ESG, like I said, almost 13, the lowest was almost negative four. Okay so, there’s some corollary relationship saying, hey, the funds that are super focused on ESG did worse than the funds that aren’t; basically oil and gas companies, right? Oil and gas has done really well in 2022. Other companies that are not more socially conscious, I assume, basically not oil and gas, haven’t done as well, like defense firms have not done better than technology. So, it’s a tough call, right? We all would love to invest in good companies that do good for the environment, good for our communities. No one wants to kill anyone. No one likes war. Not to say gun companies force countries into war; a lot of gun companies provide tools for people to do hunting and recreational activities with guns, and there’s nothing wrong with that. No one’s saying that these companies, gun companies, are bad. There are uses for guns, whether it’s militarily or recreational, that are safe and are socially responsible but have community benefit.

And it’s an awfully tough call for the government to come in and say, hey, this company, even though it does really well and is a great company, it’s not a socially responsible company, so you shouldn’t invest in it, even though it’s performed remarkably well over the last ten years. At the end of the day, it all comes down to returns, and it should, because this is a 401(k), this isn’t a charity, right? If you want to make charitable donations, you should be able to pick the charities you want. But ultimately, this is a private retirement system. You’re responsible for your own 401(k) or IRA, and ultimately you should pick the investment that does the best. If you have ESG focus, that’s great. You should be able to invest in an ESG fund, but you should have variety. So, an employer shouldn’t have to pick funds that are just ESG focused or even if there’s a tiebreaker, they shouldn’t be able to just select ESG rated funds. They should be able to give you a wide spectrum of opportunities so you can take an ESG or maybe a non-ESG fund, but it’s ultimately your decision because it’s your 401(k) money.

And that brings me up to the IRA world. This is DOL regulations. This does not impact IRA. So, thankfully the government cannot tell you what you invest your IRA, an individual retirement account, but they do, or at least trying to get their claws in, in terms of what funds you can offer to your employees, which again, I do believe it’s an overreach. I don’t think that’s their job. Their job probably should be better spent educating us on the power of the retirement system, getting everyone excited to invest, to save, so that ultimately we have the most money possible when we retire. I don’t think it’s helpful to force people to invest in ESG funds that aren’t even performing as well as the non-ESG funds and people just may say hey I want the best return. This is a game. This is real life. In a perfect world, yeah, we’re all investing in companies that produce flowers and sand and water; everything clean. But, reality is we need returns, we need money when we retire. We should be able to pick the best funds, best companies that generate the most money, and if it’s an oil company, a gun company, airplane company, mobile phone technology, whatever it is, that’s our choice. We should be able to have that opportunity and that right to make those decisions.

So, I’m not against ESG. I think it should be part of the fund selection, but I do have an issue where government is basically giving a green light to fiduciaries and plan trustees and say hey, if it’s a tie, whatever that means, just, you can offer these ESG funds. A lot of these ESG funds, by the way, more fees. If you look at the fees involved in ESG funds there’s more management, right? There’s people behind the scenes that have to make sure the companies in these funds still maintain ESG status. There’s more work; they can charge more fees; more profitable to all the investment fund managers and that’s driving this as well no matter what some of these firms say, that’s just what’s driving it.

So, what do I think, what happens? Well, I think in the next several weeks to months, we’re going to see the Biden administration come out and basically say hey, if things are equal you can go ESG. I think they’re going to rescind any Trump era focus that’s pecuniary, basically saying hey, you can pick the best fund that does and performs the best, which I thought that’s the end of the game, right? I thought the whole point of this is that we want to end up with the most amount of money in our 401(k), not supporting the companies that are most socially responsible. I never thought that was part of the equation. No one gives you a pat on the back when you have hundreds of thousands of dollars less in your 401(k) at age 72. But hey, you invested in companies that produce flowers and nice, beautiful things. Sorry you got less money, but hey, congratulations, you’re a great person. Not the way it works. That’s not reality. So, I disagree with ESG push. I don’t think the DOL should get involved with this. I think it’s great if people want to invest in funds that are ESG focused. God bless you. Great. I’m all about clean water, clean energy, helping our environment. I’m all for that. No one wants to live in smog for our kids, our grandkids, their kids. We want a very safe world from environmental social/consideration. But, that’s my individual right to make my own decision when it comes to my money. If the government wants to invest their money in ESG-type funds, their money, they can do whatever they want. But, if their returns aren’t as good, they’re going to have to answer that.

For my money, I’m going to make my decisions, because at the end of the day, I’m the one that is responsible for taking care of my family and hopefully having the most money possible in my 401(k) so I can have a good retirement and provide a legacy to my family. That’s the game. That’s the rules. The rules is to try to end up with the most money possible for your retirement, not to fund socially responsible companies. If Department of Labor or the SEC wants that, they can prop up those companies, but on an open, free marketplace, comes down to balance sheets, P&Ls and what your performance is, and companies that perform well and make a lot of money generally have the highest values, and we should be investing in those companies. Yes, we should be finding clean energy and producing a safe, healthy globe for all the citizens of the world, but individually, we need to deal with reality. In reality, we need to come up with the most amount of money possible in our retirement account, and again, this is another reason why people want to get access to their 401(k), move it into an IRA, especially a Self-Directed IRA, where they have control, and they’re not forced to invest in these ESG funds. They can do real estate or they can invest in private businesses, whether it’s a flower shop, natural energy company or a gun company, it’s their right. And so long as it doesn’t violate the Internal Revenue Code, i.e. It’s not a collectible, it’s not life insurance, or it’s not involving  a disqualified person,  self-dealing, conflict of interest, you can do it. And whether you want to invest in crypto, digital assets, precious metals, private businesses involving, as I mentioned, full gamut of our economic might, that’s our right. We should exercise that right and not have the government come in and tell us, hey, you should be investing in these funds. Yeah, I know they’re not performing great, but hey, you should feel great about yourself. Congratulations. Yeah, you have less money but you’re helping the environment and hey, that’s not really my job. I can donate my money to Greenpeace or other great organizations and the government could offer tax credits, like they’re doing to the electric car company or to clean energy companies, but that’s not my personal responsibility when it comes to my 401(k).

So, there you go. I went on not a bit of a spiel, tangent, but again. I just believe in the concept of liberty and the ability to invest in businesses and investments that you think will provide the highest return because that is your job as a participant of a 401(k); someone who’s making decisions for your 401(k). Ultimately, it’s your responsibility and no one’s going to bail you out and no one’s going to just say, hey, you’re a great guy, you’re a great lady. You invest in these ESG funds for the last 30 years and yeah, you didn’t do as well as you could have, but you’re such an amazing person, so we’re just going to write you a check for $300,000. Doesn’t work that way. You just got less money and going to have to be a little bit more challenged than you would have if you were able to choose your own investments. And that is not fair.

So, there you go. We’ll see what the Biden administration does. I do again believe they’re going to rescind the Trump administration and give more credence to ESG funds and let fiduciaries and trustees get pushed into doing these ESG investments by their investment advisors who make more fees on these ESG funds because they’re going to say, look, it’s a tiebreaker; these funds are kind of the same. Just choose the ESG fund. You’re a great employer, great person and your employees will really appreciate it. They don’t tell you that, yes, there’s more funds, I’m going to make more money and the returns may not be as good and the proof’s in the pudding. The returns have not been as good in 2022, not even close.

So, hope you guys enjoyed today’s podcast. I promise I’ll update you as soon as these rules are formalized by the Biden administration. I would think it’s going to happen in the next month or so, but yeah, we’ll see. I’m against it, as I mentioned. Why? But, who am I? Just a dumb lawyer. But for me, when I make my investment decisions, I hope I have a wide range of options and I can pick the best investment based off the best potential returns, not necessarily based off social concerns. That could be my prerogative, but I shouldn’t be forced into using and invest in those funds just because it’s helpful for the environment. That’s great, but I want to generate the highest return. That’s my preference as a retirement investor.

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