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A RECENT RULING from the Department of Labor appears to pave the way for more ESG (environmental, social and governance) mutual funds in 401(k) plans. Last week, Morningstar even launched an ESG-focused retirement plan service.
ESG assets are modest compared to other parts of the money management business, but they’re growing fast. Fund flows are substantial in the U.S. and gigantic in Europe. Investors are increasingly putting their money where their conscience is. But is that really a good thing when it comes to building our long-term wealth?
There’s data supporting the notion that stocks with high ESG scores perform relatively well. Critics, however, argue that impressive ESG fund performance simply reflects strong recent results for particular market sectors, notably technology. After all, tech firms and companies with an online-only presence have low carbon footprints—boosting their all-important “E” score.
Aligning some of your wealth with your beliefs is fine. But as investors, we also need to keep sight of the cold-hearted truth that investing is primarily about building wealth. If we want to be charitable, it might make more sense to focus on donating part of our gains to our favorite nonprofits.
One consequence of the Department of Labor’s favorable ruling for the ESG industry: 401(k) plan participants could be faced with more choice, and that often hurts investment decision-making. I’d rather just own a few low-cost index funds or even a single target-date fund. Would I ever consider an ESG fund? Only if its expense ratio was dirt cheap.
It’s very possible to invest in a simple, low cost, diversified, ESG compliant, 3 fund portfolio. I’ve helped ensure that was possible in a 401K plan (long story, but I had input on the plan lineup.)
At the same time, one has to ask what ESG means in today’s world, and does it really reflect your values. ESG is still too new to reflect everyone’s idea of ethical investing, and if you choose ESG funds I think you should be aware of that. I believe there will one day be sufficient flexibility in such funds that it will allow you to build a low cost diversified portfolio that is consistent with your personal ethical views.
Exactly right Mike