A new brief from the Center for Retirement Research at Boston College says that environmental, social and governance (ESG) screening of investments in public pension plans can have a negative impact on returns and fiduciary goals, making ESG investing unsuitable for those plans.

The brief by Alice Munnell and Anqi Chen said that public pension funds ventured into ESG investing in the 1970s with a focus on divesting from apartheid South Africa, later turning to “terror-free” investing and divestiture from gun manufacturers and most recently targeting fossil fuels because of climate change concerns.

But should public funds engage in this practice? That's the issue Munnell and Chen dissect and discuss.

Department of Labor guidance has, until recently, “clearly stated that plan trustees or other investing fiduciaries may not accept higher risk or lower returns in order to promote social, environmental, or other public policy causes,” the brief said.

It also pointed out that “[t]he bulk of social investing assets are in public pension funds … and screening in these funds is pervasive,” totaling $2.7 trillion in 2014—more than half of their total assets.

However, private defined benefit plans hold “almost none of the screened money,” probably thanks to coverage by the Employee Retirement Income Security Act of 1974 (ERISA). In addition, DOL interpretation of ERISA’s duties of loyalty and prudence has been “stringent.”

In 2015, DOL went so far as to say that ESG factors could have a direct impact on the economic value of a plan’s investment.

But while it said that ESG factors could be incorporated into the financial assessment of an investment, it did not address the use of ESG factors for screening potential investments.

The brief analyzed how divestment laws affect rates of return on public pension assets, and also considered other factors, such as the effect on plan participants and on taxpayers of ESG decisions reached by trustees, particularly if social investing produces losses, as well as the difficulty of determining pricing preferences in choosing investments in a changing social environment.

It concluded that ESG investing is not suited for public pension funds, in part because its effectiveness is limited and also because “it distracts plan sponsors from the primary purpose of pension funds—providing retirement security for their employees.”

And since decisionmakers don’t bear the risk of possible losses, it creates a principal-agent problem. To read the brief, visit the Center for Retirement Research website.

Instant Insights /

Public pension funds and socially responsible investing: Bad mix?

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