The central concept for the responsible fiduciary to understand is this: While fiduciary obligations are among the highest known to law, they are not intended to be high standards for society. The obligations of a fiduciary are to serve the predominately economic interests of investors. Whether investors’ interests coincide or conflict with the interests of society at large is beside the point. The freedom to apply environmental, social and governance issues (ESG) factors in the investment decision making process flows from increasingly compelling evidence that these factors enhance the purpose of serving the objectives of investors. In this context, societal rewards are collateral benefits. Thus, the fiduciary’s focus must be on the efficacy of the investment decision process, not the ethical integrity of that process.
Fiduciaries are expected to act with the care, skill, prudence and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use. This is the “prudent expert” standard that is required of those managing corporate retirement programs, trusts, foundations and public retirement funds.
The laws governing management of the various types of portfolios also require fiduciaries to subordinate collateral benefits to the interests of beneficiaries. Most emphatically, fiduciaries must not act in their own self-interest at the expense of those they serve. This is in keeping with the duty of loyalty owed by fiduciaries to beneficiaries. In this regard, the Uniform Prudent Investor Act is explicit in referencing inconsistency of “social investing” with the duty of loyalty “if the investment activity entails sacrificing the interests of trust beneficiaries…in favor of the interests of the persons supposedly benefited by pursuing the particular social cause.” UPIA does, however, provide that a trustee should consider “An asset’s special relationship or special value, if any, to the purposes of the trust or to one or more of the beneficiaries”.
Fiduciary law assesses prudence and loyalty based upon the care, skill, diligence and reasonableness of the manner in which decisions are made, not based upon the outcomes of those decisions. ESG factors provide attractive opportunities to enhance investment decision making. Here are examples in each area:
- Environmental — Climate legislation at the international, national and local levels is not just a theoretical possibility. Cap-and-trade regulations on emissions, carbon taxes and other methods of addressing the problem will penalize polluters. The SEC is being pressured to require climate risk disclosure in corporate documents like 10-K reports. Can a prudent and loyal expert choose to ignore this information?
- Social — Benefits are not collateral if the beneficiaries generally share the belief that they have special value. While in some cases one person’s sin is another’s recreation, abominations to civilized society are in another league altogether. A prudent decision maker could readily defend a process that assigns special value on behalf of beneficiaries to avoid financial support for outrages such as genocide, child labor, drug trafficking, terrorism and the like.
- Governance — A recent study of shareholder activism practiced by CalPERS found that “Empirical research establishes a strong link between shareholder rights and firm value and provides strong support for prudence of CalPERS’ initiatives designed to improve shareholder rights.” The study attributes the creation of $3.1 billion in wealth over a 14-year period to CalPERS’ activism.
It boils down to this: Professional judgment is required to evaluate the facts and circumstances pertinent to each portfolio under management. The responsible fiduciary must understand the interests of those they serve and decide which decision making approach better meets their objectives.
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