Secretary Scalia to Pension Funds: Manage for Returns, Not Virtue Signaling

Today, in an op-ed for The Wall Street Journal, Secretary of Labor Eugene Scalia explains the reasoning behind a new proposed rule from his department reaffirming that pension fund managers should focus exclusively on providing benefits to retirees. The current vogue for investments guided by environmental, social, and corporate governance (ESG) goals has raised concerns by many industry observers, investors, and retirees that fund managers have been playing politics (or philanthropist) with the retirement nest eggs of millions of American workers.

Management scholars, ethicists, and social activists have argued for decades that business operations should be bounded not just by following the law and striving to make a profit, but by a number of overlapping concepts of altruistic, socially beneficial conduct. Whether it flies under the name of corporate social responsibility, socially responsible investing, the triple bottom line, corporate social responsiveness, mission-driven investing, corporate citizenship, blended value, creating shared value, impact investing, social entrepreneurship, or corporate social performance, these ethical and management constructs aim to channel and control market conduct with a different set of requirements and expectations than have been traditionally applied to shareholder-owned, for-profit entities.

It’s not enough to play by the rules and appeal to customers, we have been told. Corporations must also support environmental, anti-poverty, civil rights, and diversity campaigns. They must also disclose all of their operations and expenditures to the public so that they can be suitably rated and prioritized by investment managers. Companies with sufficiently aggressive gender diversity quotas and greenhouse gas reduction schedules will be praised and invested in, while those that are lacking will be excluded from ESG-themed investment products.

While there is an army of advocates that will insist that ESG-compliant companies are on average at least as profitable as their counterparts, there’s no way to make that assertion in any meaningful way. As Secretary Scalia writes, “standards for ESG investing are often unclear and sometimes contradictory.” There is no standard for what even counts as an ESG “concern,” much less which specific policy must be adopted to address such a concern, any more than there is an objective standard for which laws are good or which candidates are fit for office. Any standard that would attract universal approval—for instance, companies should never employ slave labor—will almost certainly be a settled matter of law already. The more specific and complex ESG guidance becomes, the less agreement there will be and the less broadly applicable it will be across firms and industries.

The effort to make every company “good” and “beneficial” through ESG guidance runs into the same problem as any ethical system ever devised—people disagree about what is good and what counts as a benefit. An ESG ratings system devised by a left-leaning researcher would no doubt award extra points to a company that promoted feminism by contributing money to Planned Parenthood. A system created by a conservative expert would do doubt penalize the same activity. To the extent that such ratings constitute a particular set of social and moral views rather than reflecting value creation through commerce, using them as a guide for investments is about political activism and not financial management.

There is, of course, nothing wrong with using one’s own money to signal one’s own political beliefs. If you want to invest in Natura & Co rather than ExxonMobil, go right ahead. The Department of Labor proposed rule, however, addresses using other people’s money as a signal of a pension fund manager’s political beliefs. Scalia writes:

ESG investing poses particular concerns under the Employee Retirement Income Security Act, or Erisa, the federal law governing private retirement plans. At the heart of Erisa is the requirement that plan fiduciaries act with an “eye single” to funding the retirements of plan participants and beneficiaries. This means investment decisions must be based solely on whether they enhance retirement savings, regardless of the fiduciary’s personal preferences.

The focus on financial benefit for current and eventual retirees is a bedrock assumption of how pension plans are legally required to function—just like all public companies are supposed to be managed to maximize returns to shareholders. If someone who is a fiduciary officer of a pension fund wants to show their support for public companies that exhibit ESG-compliant behaviors, they are free to invest as much of their own money to show their allegiance as they like. But they shouldn’t be able to play games with the retirement returns of their beneficiaries for their own moral satisfaction.