Of returns, ESG, measurement, and transparency
Timothy R. Yee, AIF, CPFA?, C(k)P?, CHSA, NQPA, CSRIC?, RI(k)
President at Green Retirement, Inc.
The idea that focusing on environmental, social, and governance (ESG) measurements could lead to better performance generated an inflow of $94 billion into ESG funds in 2023. Moreover, thousands of funds and other investment products were created around ESG values and measurement. A paper published by Haas School professor, Panos Patatoukas and others seems to suggest that outperformance in a portfolio may be driven by larger companies in the portfolio that have money to fix ESG weaknesses. Likewise, these companies have the cashflow to promote and announce the improvements they've made which can lead to more investment in them.
I will be the first to admit that the 52-page paper is hard-going for someone like me. The introduction alone is 7 pages. Patatoukas is not advocating that "companies should lessen efforts to reduce carbon footprints or relax plans to be better corporate citizens". What he is noting is that these efforts need to accelerate in the face of climate change, for example.
My thoughts relative to 401k plans are first based in the immortal principles of the Department of Labor. Investments should be chosen by a defendable and repeatable process. The Investment Committee for the 401k must follow the Duty of Loyalty and the Prudent Person rule. Going beyond that, it is important not to focus just on what an investment says it believe in (ie, fighting climate change). One must ask how it is doing that (measurement and transparency). This can help avoid greenwashing.
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Performance is also an important factor to consider. It is all well and good to be ESG-focused but if the investment is not scoring well in the defendable and repeatable process, then how is it contributing to an employee's desire to retire with dignity?
And finally, just because an investment claims it is an ESG-focused fund does not make it so. The 401k advisor must dig into the underlying fundamentals to assess if it truly is.
As always, the 401k advisor and plan sponsor are trying to deliver the best overall result to employees that they can.