National Association of State Retirement Administrators

ESG - Environmental, Social and Governance

ESG investing refers to the consideration of three non-financial factors--environmental, social, and governance--in assessing an investment's potential risks and opportunities. This approach to investing is based on a belief that ESG factors can affect a portfolio's performance and therefore should be considered, with more traditional financial factors, when making investment decisions.

Types of Issues ESG Considers

In its paper, Environmental, Social, and Governance Issues in Investing; A Guide for Investment Professionals, the CFA Institute identifies issues commonly included within the ESG framework:

Environmental Issues Social Issues Governance Issues
Climate change and carbon emissions Customer satisfaction Board composition
Air and water pollution Data protection and privacy Audit committee structure
Biodiversity Gender and diversity Bribery and corruption
Deforestation Employee engagement Executive compensation
Energy efficiency Community relations Lobbying
Waste management Human rights Whistleblower schemes

According to a May 2018 report on ESG by the Governmental Accountability Office (GAO), relatively few retirement plans in the U.S. incorporate ESG principles into their investment process, and the use of ESG investing is more common among pension funds in Canada and Europe. Some large and prominent public pension funds in the U.S., however, including the California Public Employees' Retirement System (CalPERS) and the California State Teachers' Retirement System (CalSTRS), the nation's two largest public pension funds, incorporate ESG principles into their investment processes, as do the New York State Common Fund and the New York City pension funds, which also are among the nation's largest public pension funds. Other public pension funds in the U.S. that incorporate ESG principles include the Colorado Public Employees' Retirement Association (PERA), Connecticut State Treasurer, the District of Columbia Retirement Board, the Maine Public Employees' Retirement System (MainePERS), the Maryland State Pension and Retirement System, and the Oregon Investment Council.

ESG and Fiduciary Duties

ESG investing has been challenged by some who believe that this approach is contradictory to fiduciary duty, including the duties of prudence and loyalty. Advocates of ESG investing generally contend that ESG factors may be considered as part of a broader assessment of an industry or individual security, and have pointed to guidance provided by the Employee Benefits Security Administration (EBSA), to support this view.

EBSA, an agency of the U.S. Department of Labor, is responsible for the administration of the Employee Retirement Income Security Act (ERISA)--the body of federal laws that govern corporate pension plans--including providing an interpretation of fiduciary standards related to the investment of corporate pension assets. Although public pension plans are not subject to ERISA, many public pension plans rely on ERISA interpretations as a key source of guidance regarding fiduciary standards. Some EBSA interpretations in recent years have indicated that as long as certain conditions are met, social investing, economically-targeted investing, and ESG investing may comply with fiduciary standards. See, for example, Interpretive Bulletin 2015-01.

However, in its most recent Field Asset Bulletin on the subject, FAB 2018-01, EBSA was more cautious concerning whether or not non-financial factors, such as ESG, are consistent with fiduciary standards. Specifically, FAB 2018-01 states that fiduciaries must put the plan's economic interests first, before other priorities, such as social or ESG investing:

ERISA fiduciaries must always put first the economic interests of the plan in providing retirement benefits. A fiduciary’s evaluation of the economics of an investment should be focused on financial factors that have a material effect on the return and risk of an investment based on appropriate investment horizons consistent with the plan’s articulated funding and investment objectives.

Advocates of ESG Investing

Proponents believe that ESG investing is compatible with fiduciary duties and that it provides a helpful lens through which to examine an investment's potential risks and sustainability. For example, the CalSTRS report, Global Stewardship at Work, states:

ESG risks are taken into consideration to the extent that such factors bear on the financial advisability of the investment, are a material risk to the fund, or weaken the trust of a significant portion of the members of the system. Fiduciary standards do not allow CalSTRS to select or reject investments based solely on ESG risks.

A 2015 report, “Fiduciary Duty in the 21st Century,” sponsored by the United Nations Global Compact et al., based on an analysis of fiduciary laws in eight industrialized nations (including the U.S.), contends that considering ESG not only is permitted, but that fiduciary standards require it: “Failing to consider long-term investment value drivers, which include environmental, social and governance issues, in investment practice is a failure of fiduciary duty.”

GAO: More Clarity May Be Needed

The GAO report cited above found that EBSA guidance regarding ESG investing has not been clear and recommended that EBSA provide further clarification and guidance regarding ESG investing:

Fiduciaries may have difficulty determining appropriate issues to consider in investment management involving ESG factors. Fiduciaries that decide to pursue using ESG factors may face difficulty identifying and evaluating available options. Lastly, without additional information plans may be reluctant to pursue ESG strategies because they do not understand risks that could be considered material and they may not be able to effectively select and monitor an ESG strategy.

NASRA's Position

NASRA does not have a position specifically on ESG. NASRA's resolution 2019-02, – Support for Strong Fiduciary Standards in Retirement System Investments, states, in part, that NASRA:

  1. Supports strong fiduciary standards set in law by state and local governments and supports investment strategies for which the paramount goal is the financial security of pension fund assets.

  2. Opposes any attempt, either implicitly or explicitly, to direct or influence state and local government retirement system investments that circumvent the trustees' fiduciary responsibility.