Interest in sustainable and impact investing strategies has been growing at an accelerating rate, and more and more advisors are implementing such strategies. But what happens when the investments are being considered inside of a trust? Since Trustees invest and manage trust assets for the benefit of others and not for themselves, they are subject to legal duties and responsibilities when dealing with trust assets known as fiduciary duties.
How does a fiduciary duties analysis work in this context? First, there has to be an understanding as to exactly what type of sustainable and impact investing strategy is at issue. This is not a one size fits all environment and there are a number of different ways to implement a sustainable and impact investing strategy. The analysis of the applicable fiduciary duties will depend first and foremost on the particular type of strategy implemented.
With respect to ESG integration strategies, it’s probably the case that since the primary consideration in choosing to invest in such strategies is likely the financial benefit potential to the beneficiaries, there is generally no substantial fiduciary risk. By contrast, the considerations involved with respect to “Values-based Investing” or “Mission-driven Investing” strategies are different, and a Trustee will most likely need to analyze the decision in light of the fiduciary duties of loyalty, impartiality and prudent investment. It’s crucial for advisors to have a deep and broad understanding of both sustainable and impact investing and the role of a fiduciary.
Sustainable and Impact Investing Strategies
While ESG investing has become a catch all for sustainable and impact investing strategies, it’s important for advisors to understand the nuances between the different strategies, including the below:
- ESG Integration: ESG integration strategies combine material environmental, social and governance factors - which may not be reflected in the usual market data, but which may impact a company’s financial performance - with traditional financial information. This additional data is used to improve securities’ selection by expanding the information considered, with the primary objective being for the investment to outperform or track its benchmark (as it’s with traditional investment management). Examples of factors considered – energy efficiency (as vulnerability to a carbon tax, for example, down the road could impact earnings, and as energy efficiencies may increase profits by reducing fuel costs); Board independence (to remove any conflicts of interest and maximize stakeholder’s long-term interest).
- Values-based Investing: These strategies center primarily on exclusionary screens, which narrow the securities universe by excluding controversial sectors such as tobacco, gambling, and weapons.
- Mission-driven Investing: The final strategies of note focus on investing for positive environmental or social impact. Similar to values-based investing, the primary goal of mission-driven investing is something other than simply the financial analysis of the investment, it’s to create a positive environmental or social impact (for example, investing in companies working to address climate change or provide affordable housing) and is usually done through private investment funds. In contrast, the primary goal of values-based investing is to align the investment with a certain set of values.
Applicable Fiduciary Duties
Once aligned on the desired investment strategies, advisors must consider the applicable fiduciary duties that must be upheld. The duties of loyalty, impartiality, and prudent investment all play a role.
- Duty of Loyalty: A Trustee must act in the interests of the trust beneficiaries only; in no event may a Trustee’s personal social views factor into the investment decision. As such, a Trustee’s application of ESG factors, if motivated by the Trustee’s personal sense of ethics or to obtain collateral benefits for third parties, could violate the duty of loyalty. This means that when non-financial considerations come into play in connection with the investment of trust assets, the Trustee should, in general, review any guidance provided by the Settlor with respect to such considerations and then, if none, the Trustee may look to the views and priorities of the beneficiaries (which may be varied). A comment to the Uniform Prudent Investor Act notes that “[n]o form of ‘social investing’ is consistent with the duty of loyalty if the investment activity entails sacrificing the interests of trust beneficiaries-for example, by accepting below-market returns-in favor of the interests of the persons supposedly benefitted by pursuing the particular social cause.”
- Duty of Impartiality: A Trustee must treat all beneficiaries equitably, whether primary or secondary, current or remainder, depending on the terms of the trust instrument. It’s possible (if not likely) that not all beneficiaries are on the same page with respect to social issues and sustainable and impact investing generally. A Trustee must balance the views and interests of all beneficiaries and ensure that the desires of one beneficiary are not being satisfied at the expense of those of other beneficiaries.
- Duty of Prudent Investment: The essence of the prudent investment rule is that, absent any prohibitions in the trust document, while no single investment is per se prohibited, its potential impact on the trust’s investment portfolio must be carefully analyzed and considered, as well as its appropriateness given the trust’s terms and objectives and the needs and desires of the beneficiaries. While the Uniform Prudent Investor Act (adopted in most states) does not speak to sustainable and impact investing directly, it does specifically call for the Trustee to consider the “special relationship or special value” of an asset to the purposes of the trust or to one or more of the beneficiaries of the trust. In 2018, Delaware incorporated the concept of impact investing into its statute governing trusts; title 12 section 3302 of the Delaware Code now provides, in pertinent part, as follows: “In making investment decisions, a fiduciary may consider the general economic conditions, the anticipated tax consequences of the investment and the anticipated duration of the account and the needs of the beneficiaries; when considering the needs of the beneficiaries, the fiduciary may take into account the financial needs of the beneficiaries as well as the beneficiaries' personal values, including the beneficiaries' desire to engage in sustainable investing strategies that align with the beneficiaries' social, environmental, governance or other values or beliefs of the beneficiaries.”
Again, for ESG integration strategies, it’s likely the case that, since the primary consideration in choosing to invest is the financial benefit potential to the beneficiaries, there is generally no substantial fiduciary risk presented. ESG integration strategies have been found to be more likely to result in better-than-benchmark returns than negative screens or exclusions. There is growing evidence that long-term risk-adjusted returns can be improved by properly considering ESG factors in the investment process.
The principal impetus for considering investment in Mission-driven Investing strategies and Values-based Investing strategies is likely to be (but may not always be) something other than to maximize the overall financial benefit potential to beneficiaries, and therefore such strategies typically have the flexibility to accept returns that range from concessionary to market rate. As such, the decision requires a more thorough analysis in light of the fiduciary duties of loyalty, impartiality and prudent investment.
The landscape of sustainable and impact investing is vast and adding a fiduciary overlay creates additional complexity. But with more and more data accessible which outlines the impact of ESG integration strategies on investment positive returns, the question that fiduciaries should be asking is whether they must only consider managers that take ESG factors into account when investing. It’s becoming essential for fiduciaries to truly understand the landscape of sustainable and impact investing and how it fits in with the role of a fiduciary.
Elisabeth Madden is Managing Director of Trust & Estate Advisory, and Candice Dial is Senior Vice President and Director of ESG Investments, both at Rockefeller Capital Management.