Embed ESG in Pension/Retirement Funds

By George P. Nassos
The ESG concept has made great progress since it was first developed by the Brundtland Commission in 1987 and called “Sustainable Development”, later renamed sustainability. In 1994, John Elkington gave it a sub name of “Triple Bottom Line”, referring to the three pillars of environmental integrity, social equity, and economic viability. About 15 years ago, this environmental concept was redefined as Environmental, Social and Governance or ESG. Basically, it includes the environmental and social pillars of the “triple bottom line” but replaced “economic viability” with “governance”. Governance refers to a company’s oversight, structures, policies, rules, and controls for overseeing the environmental and social goals. If this pillar is in place and activated accordingly, the economic benefits will follow.

Shortly after the creation of the ESG corporate model, companies adopting this principle started to perform exceptionally well. If fact, some mutual funds were created strictly for ESG performing companies because of their superior performance. These funds started to out-perform the Dow-Jones average, and this growth of ESG assets under management may exceed $50 trillion by 2025 with 50% of these ESG funds being under management in the EU (per Bloomberg) or $30 trillion by 2030 (per Forbes). In either case there will be substantial growth in ESG investments.

Over the past five years, however, performance has decreased 2-3%. Why has there been a decline in the performance of ESG companies if such great growth has been forecasted? While I believe that all companies should practice the ESG principles, there are many that are still focused strictly on maximizing profitability. When they see the growing investments in ESG companies, they decide to become an ESG company in name only. They will create a Chief Sustainability Officer position, fill it, and present it and its duties to all the stakeholders as well as the financial media. This has led to more and more “greenwashing”. Now we also have the political issue between our two major parties.

Last month, the House of Representatives passed a bill to block the Labor Department rule allowing fund managers to consider ESG practices for retirement plans, citing that retirement plans should focus solely on maximizing returns instead of “woke” agendas, whatever “woke” agenda are. The Senate then passed the bill in a 50-46 vote, with two Democrats crossing party lines to support the effort, which will send the bill to the president for his signature. Fortunately, the president vetoed the bill with the first veto of his term, but I am sure the battle isn’t over. If the House and Senate truly want to maximize the returns of retirement investments, then it makes much more sense to focus on ESG investing. It has been shown that ESG funds truly outperform the non-ESG funds. However, this does not happen overnight. The ESG funds do exceptionally well in the long run. In fact, as the environment continues to deteriorate, following the ESG principles will become more important than ever.

Companies focusing on ESG must place most of their effort in the G in order to establish and implement all the goals of E and S. It is also critical to disclose the details of their ESG efforts in the same manner that the companies are accustomed to disclosing their financial performance. They need to provide the necessary data required by the various ESG reporting standards such as GRI, SASB, ISSB and others. The various investment funds for pensions and retirement must consider not only the financial performance of the company but also, and just as important, the ESG performance. Since retirement and pension funds are created for the long term, it makes sense to invest in funds that have long term growth. Hopefully, the politicians in Washington will move in this direction.