US proposes dropping ESG investments from retirement funds

Globally, Dow Jones data showed 150 out of 200 ESG-­focused share funds “outpaced the average return of a fund’s broader category” during the early months of the crisis. Picture: Andy Rogers

After a remarkable run of success in the investment sector, ethical investing has received an unwelcome jolt from the US government with a Trump administration proposal to remove so-called Environmental, Social and Governance (ESG) investments from retirement funds.

With the policy-making US Department of Labor controlling funds representing one third of the entire US sharemarket - the announcement has sent shockwaves through the global ESG sector.

The CEO of the Responsible Investment Association Australasia, Simon O’Connor, has branded the measure as “a backward step”.

Meanwhile, investment research group Morningstar warned: “The Trump move could conceivably spark similar measures by other regulators in the months ahead.”

With funds of $US9 trillion ($13 trillion) under its control, the US Department of Labor says that fund managers acting on behalf of American workers should only follow “objective risk criteria” when buying stocks and bonds.

In essence, the proposal puts forward a hardline traditional view of investment objectives where the sole purpose of retirement funds is to make money for members.

Opponents of ESG investing - including companies in the mining, defence and tobacco that have been sidelined by ESG consultants - regularly argue superannuation funds should not be run based on ESG factors.

But the US attempt to order investing based on “objective risk return” stands as one of the first official policy measures that could set back an industry that has thrived in recent times as “clean” technology companies have spearheaded outperformance by ESG funds over conventional funds across the market.

With more than half of all institutional investing in Australia now classed as “responsible investment”, the ESG sector has been unstoppable, bringing in better-than-average returns, including through the pandemic.

Among mid-year reports on general investment performance, Rainmaker Australia reported “if a (MySuper) fund member invested in general balanced or growth options they would have been 1.5 per cent better off over the 12 months to the end of March if they chose ESG options”.

Globally, Dow Jones data showed 150 out of 200 ESG-­focused share funds “outpaced the average return of a fund’s broader category” during the early months of the crisis.

Perhaps the most visible signs of success for the local ESG sector has been the extraordinary share price run of the $700m ASX-listed Australian Ethical Investment, one of the most established funds in the sector.

The March crash knocked more than 50 per cent off the stock as it sunk to near $2. With the broader market recovery, AEF reached a record high of $9.07 though it has since lost nearly a third of its price, trading near $6.27 this week.

Will Simpson, the chief executive of Blue Ocean Capital, a fund manager that concentrates on “high-quality ESG factors”, says: “To restrict or eliminate environmental, social, and governance (ESG) investments on the basis of risk and return is fundamentally flawed in that the very function of ESG is to limit risk and maximise long-term returns. I would suspect substantial kickback regarding the proposed ruling both from fiduciaries and investors - our experience in ESG has underpinned our performance.”

The new proposal is also likely to revive arguments about the role of Australia’s biggest superannuation funds as several local funds have come under pressure in recent times.

Union-linked industry funds in particular have regularly been pushed to achieve social and environmental objectives through their wider investing activity.