Investors use a variety of strategies to inform their decisions about which stocks to buy. For many, investing is more than just a way to make money -- it's also an opportunity to express their values. Choosing individual stocks in which to invest makes you an owner of those companies, and in some investors' minds, that means taking an active role in what those companies do and how they behave.
Socially responsible investing using environmental, social, and corporate governance (ESG) factors has become increasingly popular in recent years. Yet it has also become a hot-button issue politically, drawing criticism from some who believe that the adoption of ESG investing principles infringes on their ability to invest how they want.
Below, you'll learn more about EST investing and what has happened recently to bring it into the spotlight.
What ESG investing is
ESG investing seeks to choose investments in companies whose behavior reflects an awareness of key elements of social responsibility.
- On the environmental side, many ESG investors seek out companies that have policies on limiting greenhouse gas emissions in an effort to mitigate climate change, as well as seeking to adopt renewable energy and water use policies.
- Socially, ESG investors tend to favor companies that offer employees higher pay and benefits as well as promoting other social justice issues.
- And on the governance side, ESG investing promotes reasonable levels of executive compensation, diverse leadership within a company, and transparent dealings with stakeholders.
Exactly what that means depends on each individual ESG investor. For instance, some ESG proponents argue that oil and gas exploration and production companies should automatically get excluded because of the impact of fossil fuel use on climate change. Yet others have embraced certain energy companies that have made efforts to begin a transition toward renewable energy, even if they currently rely on oil and natural gas for their revenue and profits.
Sources of controversy
The ESG debate has landed front and center in a somewhat unexpected realm: 401(k) plans. Early on, the Department of Labor, which administers rules related to employer-sponsored retirement plans, was skeptical about allowing ESG-focused funds as investment options. That made employers reticent to seek to include them as investment choices in their plans.
Yet during the Obama administration, the Labor Department said that plan fiduciaries could consider ESG factors in choosing investments. The Trump administration reversed that stance, but the Biden administration has proposed a rule that would once again allow plan providers to consider investment options with an ESG bent.
Proponents of ESG investing argue that employee participants should have the choice to select ESG investments if they wish. Opponents argue that they don't want to be forced into an ESG-focused investment, and they object to the idea that plan sponsors could make ESG investments the default, requiring them to opt out in order to avoid going against their particular preferences.
More choice is good for all
The best compromise solution would be a rule that allows plan sponsors to make ESG investments available to plan participants while also requiring that conventional funds that don't focus explicitly on ESG remain available as options as well. That solution maximizes the amount of choice available to every employee participating in a 401(k) plan.
Unfortunately, though, many employers worry that giving employees too many choices could create liability if participants make poor choices. That might make some plan sponsors reluctant to include ESG-focused funds even if the Biden administration's Labor Department explicitly allows them.
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