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Labor Department’s ESG Proposal Could Limit BlackRock’s ESG Strategy

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The rise of environmental, social, and governance (ESG) investing is again prompting fierce debate now that the Department of Labor (DOL) released a new proposal that is a clarification to past rules and regulations requiring that private pension fund managers must be singularly focused on maximizing financial returns for their beneficiaries. The fiduciary fund managers cannot make investment decisions based on amorphous ESG factors that consist of loosely applied, non-accounting measures used by investors, analysts and activists to evaluate corporations. 

Some investment managers have differentiated themselves by promoting ESG as a value-added investment approach. BlackRockBLK CEO Larry Fink recently gained a lot of attention by marketing his commitment to advancing ESG measures, such as corporate purpose, stakeholder capitalism, and climate. Many believe that buying shares of companies with high ESG scores will provide market incentives for sustainable investing initiatives, and BlackRock is banking on investors flocking to this initiative. But are the returns to investors worth the added fees of these actively managed investment funds? Thus far, the evidence is mixed and investors are left to wonder whether BlackRock’s definition of ESG is the same as Fidelity’s or Vanguard’s or Goldman SachsGS’.

BlackRock drags a fee off the top, and thereby has an incentive to promote its ESG initiative that has nothing to do with creating value for portfolio companies, but instead will generate higher fees if funds under management increase. Veteran investment managers know that if the ESG strategy does provide extraordinary returns, the flood of capital into it will eventually drive down the rate of return to investors.  Arbitrage opportunities across different investment strategies do not persist. The DOL understands investment markets and is now compelled to again address the age-old principal agent problem and fiduciary duty. 

BlackRock announced in January its initiative to hold companies accountable on climate change, a key consideration for many ESG focused investors. The impact was seen during the season of annual meetings, when BlackRock voted the shares held in its funds in favor of climate proposals resolutions or against board members for climate considerations during these annual meetings. However, BlackRock’s support or non-support for various proposals at companies remains vague and arbitrary, despite increased disclosure regarding their voting rationale this year through voting bulletins, which has prompted increased scrutiny by proponents and detractors of ESG alike.  Democratic Senators began an inquiry about BlackRock’s climate commitments and solicited support from the firm for legislation to mandate various ESG disclosures. As BlackRock makes asset purchases for the Federal Reserve during the pandemic, Republican Senators have questioned whether BlackRock would discriminate against fossil fuel companies.

What’s Sauce For The Goose....

Indeed, BlackRock’s initiative appears to have opened a Pandora’s box. Two Senators recently started inquiries into why BlackRock does not apply ESG principles internally. Citing BlackRock’s voting record in the annual meetings and its cooperation with relatively small activist investors, the Senators ask why BlackRock does not apply the same level of scrutiny, diligence and good citizenship to its investments in Chinese companies. Why? The answer appears to be money. BlackRock is betting on China as its next big growth opportunity and is hypocritically currying favor with the Chinese government, the ultimate management and owner of most Chinese firms listed on U.S. exchanges. BlackRock’s access to Chinese firms and markets would certainly be curtailed if it pursued activist labor and climate shareholder votes against Chinese firms.

Investment management companies will not right the ills of the world. That some members of Congress want to try this approach by literally engaging in a proxy war when they should be passing legislation to address major issues like climate change is laughable. Investors work to make a rate of return. The DOL’s proposed ERISA rule again reminds pension funds managers that their fiduciary duty is to the beneficiaries. The beneficiaries can then decide what to do with their own funds.

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