On Monday, President Joe Biden vetoed a bill that would have effectively banned ESG, or “Environmental, Social and Governance,” investments in tax-advantaged retirement accounts.
This veto is the first of Biden’s term in office. It keeps in place a rule issued by the Department of Labor in November allowing retirement managers to take social and environmental issues into account when building portfolios. The administration took pains to note that this rule is not a mandate. No portfolio manager is required to offer ESG options, nor are individual investors required to select them. This regulation instead clarifies that asset managers can offer ESG options if they choose.
This is the latest step in a fierce debate over socially conscious investing, which was effectively banned in retirement accounts by the Donald Trump Administration in 2020.
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The idea behind ESG investment is that portfolio managers will invest their client’s money in ways that consider the environmental, social or governmental impact of the underlying assets. For example, it’s not uncommon for investment firms to now offer funds that don’t invest in fossil fuel companies, or that actively try to invest in alternative energy and related firms.
Professional investors have offered ESG investments for more than 20 years. This is a financial category that asset managers build portfolios around, often as a marketing tool to attract new investors. Investors can select or ignore these portfolios in the same way that they do risk-related funds and industry investments, and ESG portfolios have grown particularly popular among young investors who would like their money to reflect their personal and political values.
However, in recent years this practice has also attracted severe criticism from political conservatives. The option to simply ignore this financial product has not slowed the opposition, if not anger, from the right, which portrays ESG investment as the woke, cultural capture of finance by left-wing politics.
This led to a 2020 rule by the Trump Administration which effectively banned all ERISA retirement accounts from considering ESG factors in their portfolios. The rule required plan fiduciaries to only consider financial performance rather than any “non-pecuniary goals,” with significant penalties for money managers who did not comply.
In external statements the then-head of the Department of Labor indicated that the rule was intended as a response and reaction to the growth of ESG investment. This led most observers to conclude that Department of Labor enforcement would specifically enforce this rule against any plan administrators who offered ESG portfolios.
The Trump-era rule was passed in late 2020 and did not take effect before the administration left office. When the Biden Administration began, it reversed this rule. In November, 2022, the Biden Department of Labor issued an additional regulation that specifically allows ERISA-related retirement accounts to consider environmental, social and governance factors in their investments if they choose to do so.
Congressional Republicans opposed the Biden Administration’s new regulation and passed the recent bill as an effort to overturn it. It is unlikely that Republicans will muster the votes to overcome Biden’s veto, as they would need significant Democratic support to find the two-thirds majority necessary.
Critics of this rule, and of Biden’s veto, insist that it will harm American investors and worsen the growing retirement crisis. Their argument is that ESG portfolios put political factors before financial return, which leads to worse overall returns and exposes investors to a bad financial product. This is to the extent that critics of ESG investment choose to make financial arguments at all. Many couch their criticisms in more conspiratorial terms, such as House Speaker Kevin McCarthy’s suggestion on Twitter that the Biden administration intends to siphon off retirement dollars toward left wing political causes.
The White House has argued that the opposite is true, announcing in a tweet that the proposed ban on ESG investment would “risk your retirement savings by making it illegal to consider risk factors MAGA House Republicans don’t like.”
There is no strong evidence in either direction.
Some analysts suggest that ESG investments tend to underperform the market, while others find that they tend to meet or beat the market. To the extent that the research in this area produces consistent findings, it suggests that socially conscious portfolios often produce middling results with fewer boom-and-bust cycles than the market at large.
This rule, and the vetoed bill, only affect tax-advantaged retirement accounts. They do not address private portfolios that consider environmental, social or political issues.
President Joe Biden issued his first veto on Monday, striking down a law that would have restricted socially-conscious investment options in retirement accounts.
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