Is ESG investing compatible with being a fiduciary? Our new research provides a road map for fiduciaries as they evaluate strategies incorporating ESG considerations.
This transcript has been generated by an A.I. tool. Please excuse any typos.
00:09 - 01:02
Hello, and welcome to On Purpose. I'm your host, Travis Allen, senior investment strategist and national director of Purpose Driven Strategies at Bernstein. Today, I'm thrilled to be joined by Jennifer Goode, a director in our Wealth Strategies Group. Jennifer recently led the efforts to produce a research paper that discusses the intersection of fiduciary responsibility with growing considerations around environmental, social and governance or ESG investing. Jennifer comes to this work with a long background as a practicing attorney. For 15 years, she focused primarily on tax and trusts in estates. The Wealth Strategies Group, to which Jennifer belongs, is a multidisciplinary group of professionals with experience in helping families and individuals navigate wealth, tax and investment planning. Jennifer, welcome. Thrilled to have you on the podcast.
01:03 - 01:04
Thanks for having me.
01:04 - 01:52
Well, I'm excited about this topic today because, you know, it's one of those things that comes up a lot and there's a lot of misinformation. And I think the work that you have done will go pretty far in giving people better insights into how to consider these issues around ESG and fiduciary responsibility. So maybe let's just start with some level setting. ESG received its fair amount of criticism lately several high profile articles in academia and in the media. Of course, the famous Elon Musk ESG is a scam or the economist's cover with ESG is broken. So I'm just curious, is that part of what led you to embark on writing this piece?
01:52 - 02:13
Oh, Elon, yes. This is a field that has been sort of ever expanding in recent years. And there's a lot of confusion about terminology, about how to implement a strategy appropriately, what the measurement standards are. All of these things have added up to a lot of confusion about what it is people are buying into.
02:13 - 02:57
And for fiduciaries, how can they interact with these strategies while still satisfying the duties that are imposed on them as fiduciaries, as individuals who are beholden to invest on behalf of someone else and fiduciary is especially are very sensitive to this because they face liability if an individual invests in something and it goes south. It's not as if they're going to wake up tomorrow and have someone else suing them for that outcome and fiduciary space. A lot of oversight and potential liability from their beneficiaries. And so they're going to be a little bit more hesitant and a little bit more concerned about new products and strategies that they maybe don't necessarily understand.
02:57 - 03:14
Yeah, I'm so glad that you took us into the fiduciary area so quickly. Obviously, it's in the title of the piece that you wrote. So, let's take a step back and maybe talk for a minute about who these fiduciaries are and what makes ESG or considering ESG harder for them.
03:15 - 03:51
Sure. So what do we mean by fiduciary is there's sort of three fiduciaries that we addressed with this piece. The first is, from my standpoint, kind of traditional fiduciary. So a trustee of a trust, someone who is named under a trust document or even a will to manage assets for the benefit of beneficiaries. And they are governed by fiduciary duties established under common law, which just means case law as it's evolved over time. And that's typically going to be state case law statutes that are adopted in these state under which governs the trust and then also the trust agreement itself.
03:51 - 04:22
Additionally, we talk about individuals who make decisions for charities. So these are going to be sort of the board of trustees for a charity that's structured as an entity or for those charities that are structured as trusts. It's going to get the trustees named after the documents. And then last but not least, you have folks who are administering private retirement plans. These plans, under federal law, they impose fiduciary duties that are somewhat similar to the duties that face trustees of private trusts. So those are the three categories that we looked at for purposes of this paper.
04:23 - 04:52
And again, as I kind of referenced earlier, these folks are facing outsiders who can kind of Monday morning quarterback their investment choices, that they're going to be a little bit cautious there. In addition, specifically with trustees of trusts, they're facing potential review by beneficiaries who may not even be born at the time that the decision is made. And so there's just a lot that can happen in between the investment decision itself and the time that they're forced to answer for it or to explain it.
04:52 - 05:26
Jennifer, thanks for that. I think what's interesting is that this touches so many people, right? It could be somebody who's a family member, an uncle who's just serving as trustee for their nieces and nephews. It could be someone who's active in their local community and on the board of an organization that has an endowment that needs to be managed. And perhaps by some accident, they've ended up on the Finance or Investment Committee. Or it could be somebody who's running a business who is providing a 401k plan.
05:27 - 06:12
Right, for their employees. And they have the fiduciary oversight of that plan. And I think in all of these areas, there's been some pressure to think about how ESG may or may not fit into the oversight of the investment portfolios. And from my own experience, I feel like if you just start with the trustees, for the most part, I sensed some hesitancy to move towards ESG strategies. Maybe it's just because trustees feel more comfortable being conservative and they view this as being. Risky. Why do you think so many trustees and attorneys have landed on the idea that ESG and fiduciary duties are incompatible?
06:12 - 06:59
I mean, Travis, as you know, I think a lot of that has to do with the history of ESG and its sort of forerunners. So, there was socially responsible investing, which typically refers to the very beginnings of this type of investment, and it really started with religious investing. So think, for example, the Quakers who chose to exclude any industry that was sort of touching the slave trade or gambling, alcohol, the kind of the sin stocks that we think of. And these were strategies that really sort of broadly excluded industries based on their religious and moral grounds. And then we saw that evolve in the sixties and seventies to deal with the Vietnam War Agent Orange Industries. And then we saw in the eighties a push to divest from South Africa in protest to apartheid.
07:00 - 07:26
And so, again, these were all strategies that weren't really looking at sort of the interaction between the industries or markets or assets that were being excluded and the financial impact of that. And so I think that there are a lot of folks that are sort of thinking of that and thinking of sort of subjecting or subordinating the beneficial interest, the financial interest to these sort of larger, loftier environmental or social goals.
07:27 - 08:19
And that's just not really the case today with a lot of ESG investing. There is still investing out there. I don't mean to say that it's not, but when for purposes of our piece, we were really looking at modern day ESG investing strategies, specifically ESG integration and more ESG focused strategies that really focus in on the ways that environmental, social and governance factors impact the financial performance of both a company at the lower level and then a portfolio probably for the investor. And so there's really more of a focus on the interplay between those like ESG factors or goals and the ultimate financial outcome. And so there's more consideration of that. And nowadays you can invest in a way that furthers an environmental or social goal, but not give up the financial benefit, the financial return that you're looking for.
08:19 - 08:47
So, Jennifer, let's get into specifics because you talk a lot in the piece about, you know, what these duties are, that fiduciary have had to consider as they're thinking about ESG. And what I'd like you to do is sort of walk us through each one and maybe explain why they matter and give us some sense of how you interpret them applying to ESG.
08:47 - 09:09
Sure. So this is going to be I will walk you through, but it's going to be kind of high level because this gets a little dense and a little nerdy, even for a tax lawyer like myself. So we'll try and keep an eye level. The two duties that we looked at and which I would say are probably the two primary duties that control investment decisions for a fiduciary would be the duty of loyalty and the duty of care.
09:09 - 09:54
So let's start with the duty of loyalty. The duty of loyalty says that the fiduciary must act in the interests of the beneficiaries. And here, it's important to note that there's a distinction between the duty of loyalty as it applies to trustees, of trusts, and as it applies to individuals making decisions on behalf of a charity that's formed as an entity. One is a bit more stringent than the other, so the duty of loyalty as it applies to trustees of trusts requires that they act in the sole interests of the beneficiary. And there's actually something called the no further inquiry role that developed under case law that said, if there was even any evidence of a conflict of interest or self-dealing, that the action would be essentially voidable by the beneficiaries.
09:54 - 10:34
Now we take a different stance on that. There's been some conversation about this amongst academics that says that this would sort of rule out ESG altogether because you are automatically considering someone else's interests by trying to improve the environment for strangers across the world. That isn't where we came out in terms of our analysis. We actually found that, historically speaking, conflicts of interest and self-dealing really dealt with situations where you had a trustee who was on both sides of the transaction, so someone who's selling property to themselves or someone who's selling property to a spouse or a child, someone that they would be unable to kind of deal with fairly while still monitoring the beneficiaries best interests.
10:34 - 11:32
Where we came to with respect to our analysis is that when you are a trustee of a trust, you're required to invest in something that serves the best interests of the beneficiaries. So, you know, ESG investing, you don't have self-dealing. Typically, the trustee is not going to be financially benefited by this strategy. And you're typically not investing in something that's going to benefit, at least directly your related party. So folks that you are financially involved with or your relatives you're more sort of investing in. Something that might improve the living standard for strangers across the world. So in that instance, then you really can just invest, making sure that you're looking at the best interest of the beneficiaries. Is this strategy performing reasonably as well, with about the same amount of risk as available alternatives? You know, you're looking at the cost. You're looking at how this interacts with the overall portfolio to support the income needs, the capital appreciation needs. That's just the general of the financial needs of the beneficiaries.
11:33 - 12:18
Let me just restate quickly. So, the duty of loyalty historically has been, by some people, interpreted as an issue because you are considering the interests of people other than the beneficiary by thinking about environmental, social and governance issues. So, so for example, Jennifer, if I am considering two different real estate investment opportunities and one of them focuses on creating affordable housing, which is a big issue in a lot of places around the country, especially in large cities where it's become harder and harder for people at the median or below median income to afford to live anywhere near where they work.
12:18 - 12:40
So if I'm investing in that type of strategy versus just another, you know, real estate strategy, how do I think about that in terms of at what point am I running afoul of the duty of loyalty versus, you know, what are some of the things that should give me comfort that as a trustee, I'm investing in a way that's still consistent with my duty of loyalty.
12:40 - 13:19
So the first step would be to look at make sure that you are not engaging in self-dealing. So obviously you can't invest in a real estate venture in which you have a financial interest. And then the second step would be a similar analysis, but looking at the people around you, so you're not investing in something that's financially going to benefit your close family members or a partner in your partnership or some other person with whom you have a financial relationship. Assuming that you clear both those hurdles, then the step really is to look at whether or not this is in the best interests of the beneficiaries. Does this make financial sense for them and for the trust long term? And you can kind of compare it to a strategy with an independent, completely independent analysis.
13:19 - 13:44
So are two examples. One, that factors in ESG factors and so may benefit a third party somewhere out there that you don't know. And your other strategy that doesn't incorporate any sort of third party considerations, if they're approximately equal in terms of risk and return and cost, then you're on equal footing. And I would argue that you could engage in either and satisfy the best interests of the beneficiaries and your duty of loyalty.
13:45 - 14:13
Now, one thing I would little Asterix I would put there is that what we're talking about right now is for trustees of trusts. But when you shift over to individuals for making decisions for charity, you can really sort of start to broaden that idea of best interest. So now you can look at whether or not this investment is pushing forward your charitable mission. So it's a little bit more lenient in terms of a standard because you can accept maybe lowered return if you are somehow providing a benefit towards your charitable mission.
14:14 - 14:48
So continuing with the example that I started with, with the real estate investment opportunity. If I am a fiduciary for an organisation whose part of its mission is to address the lack of affordable housing in the city where I live, if I find a real estate investment that maybe doesn't have the same risk or return characteristics as a traditional investment, but furthers my mission, you're saying that that, again, might be consistent with the duty of loyalty because the charitable organization has that as part of its mission.
14:48 - 15:03
That's right. That would be part of your analysis. You'd have to figure out if it's worth it to maybe forgo some of the financial return in order to push forward the non-financial goals of the organization. So, it's a little bit more of a nuanced review, I'd say, for individuals acting on behalf of charity.
15:04 - 15:15
So, tell us about the duty of care and how that fits into the analysis of whether or not ESG is consistent with the role of being a fiduciary.
15:15 - 15:52
So, the duty of care is most often formulated as the prudent investor role. I would argue that you are very familiar with it, but it really sort of focuses in on the way the process by which you analyze an investment in the context of the larger portfolio. Let's say one strategy is more sort of return seeking. Okay, fine. Then maybe another part of the portfolio and looking more towards risk mitigating to make sure at the end of the day, the financial output meets the needs of the beneficiaries. It also emboldens fiduciary, is to kind of look at risk a little bit differently than historically it might have.
15:53 - 16:16
So again, you can look at a compensated risk. So compensated risk means if you are engaging with a company that maybe the financial. So, performance is a little bit riskier, but in return, they're going to give you a larger financial payout. It's okay for you to kind of consider building that into the portfolio again, provided that you are making sure that maybe the rest of the portfolio is maybe a little bit less risky.
16:17 - 16:53
The other component of the duty of care is the diversification of the portfolios. You know, for example, when you have rising interest rates and inflation, you can't really ask for extra return because that's not a company specific risk. But what you can do is diversify the portfolios of assets who are going to react differently to that large market stimuli. You're going to have some assets that react positively to rising interest rates, while others might react negatively. And that way you're going to kind of meter out the market volatility and kind of bring your portfolio overall. So those are, I would say, probably the largest components of the degree of care.
16:53 - 17:32
I guess one other thing I could mention is the duty to document, document, document, document. It's like a lawyer's dream. Every decision that you're making and how you're making it keep good records and make sure beneficiaries have access to that if they need it. So, with respect to ESG, a lot of kind of what we were talking about in terms of comparing ESG strategy to maybe its non ESG peers and deciding how it fits into the overall portfolio and the beneficiaries needs, that all goes to the duty of care. You're going to be analyzing these strategies and comparison to the alternatives and documenting why you made the decision, how you anticipate it'll play out long term for the beneficiaries and how it's going to meet their needs.
17:33 - 18:15
Yeah. When you when you talk about the duty of care in terms of the prudent investor rule, now you're speaking my language. And so, you know, thank you for that explanation. But what strikes me about the duty of care and the duty of loyalty is that they sound like things that trustees should be doing anyway. Even if it's not an ESG strategy, they still should be looking at whether or not they have any conflicts and to make sure there's no self-dealing and all of those types of things. So, it doesn't sound like I know this is, you know, adding an additional lens through which to view these questions, but it sounds like these are steps and processes that trustees should be going through anyway in evaluating any investment for their portfolios. Is that right?
18:15 - 18:48
Yeah, I agree. I mean, I think that's where we came out at the end of our piece was just that ESG investing is not that different than a lot of other active management strategies. You need to look at it in a very similar sense. You're going to look at its potential for volatility, its potential for return. The manager that's implementing, I mean, that's huge. Who is actually implementing the strategy and how it's constructed. So, you know, and I think interacting with it, you're right, you're absolutely right. This is very similar to how trustees should be looking at and evaluating strategies both ESG and non SGA like.
18:49 - 19:15
Yeah, one of the things I really like about the piece is that there's a section that sort of gives sort of practical steps for people to take if they're faced with this issue of considering ESG or impact or sustainable strategies for portfolio. So, if I'm a trustee overseeing a trust for the benefit of my nieces and nephews, what are sort of the three things that I should be sure to do?
19:15 - 19:44
I mean, I think you're going to first evaluate what it is that you need to do, what the beneficiary of needs are, and how the trust agreement deals with those needs, what it authorizes you to do. So, you're going to determine whether or not you've got current income needs versus long term growth and whether the trust is going to allow you to prioritize one over the other. Then you need to evaluate how a strategy fits within those goals and those needs as part of the overall portfolio and whether or not the trust agreement modifies your fiduciary duty.
19:44 - 20:17
We talked about this idea of the sole interests. A trustee has to invest in the sole interests of the beneficiaries. That is kind of a default standard. Trust can actually say, you know what, let's just say best interests. So don't worry so much about the sole interests, in which case you have a lesser standard of review for the investment decisions that you're making. And it could even explicitly authorize ESG investing. That's something that we for those who are really interested in ESG investing and want that to be a part of the legacy that they leave their beneficiaries in trust.
20:17 - 20:51
We strongly recommend that they address ESG investing, expressly authorize it under the trust document. And in fact, more and more states are actually adopting and expressly allowing people to build that into their trust documents. And then last but not least, you need to evaluate whether the strategy constitutes self-dealing or conflict of interest. If we've got this this higher standard of review for a trustee who's evaluating strategy, then we need to make sure that we're not falling into the no further inequity role and this higher level of review due to a conflict of interest or self-dealing.
20:52 - 21:28
So, Jennifer, I'm really glad that you went through that because I think one of the reasons why this has been so difficult for trustees is that I haven't seen. Many trusts that explicitly authorize or encourage the use of ESG focused or even ESG integration investment strategies is that's something that's starting to grow. And so if somebody is listening to this podcast and they're going to be revisiting their wills and trust in the next year or two, is this something they should reach out and talk to their trust in a state attorney about?
21:29 - 22:27
Yes, absolutely. It is a new and developing area, both for investment and for law. There's not a ton of case law that's on point. I think there's virtually no case on point with respect to modern day ESG investing strategies, although I suspect that will change. But the first line of defense in terms of protecting your beneficiaries and allowing them to really freely think of these strategies, is to build it into the document, put it in as a statement of intent. I want my trustee to think about this when they're investing for my beneficiaries. Create and also think about potentially putting in a provision that requires the beneficiaries to give the trustee their thoughts on ESG. So you're encouraging discourse and conversation about this topic, and then you can also encourage that there be an investment policy statement for the trust, and that's something that the trustee can work on with the beneficiaries in terms of trying to come up with rules of the road for investing, based on your views, based on the grantors views of ESG.
22:27 - 22:51
Let's do the same thing for folks who are fiduciary of a charitable organization. A lot of investment committees are thinking about ESG today. I know because I've been involved in a lot of conversations with finance and investment committees and boards that are starting to think about how to move more in that direction. So, what are some of the steps that that I should consider in that capacity? Sure.
22:51 - 23:23
It's similar in that you're trying to evaluate the needs in this place instead of beneficiaries of your charitable mission. So, you're trying to think about what your charitable mission is, how you want to achieve it, and how that translates into the various funds that the charity has. They're going to keep, obviously, some cash on hand. There's going to be some short-term investing and some long-term investing. And you're going to want to think about how ESG plays a role in at least the short-term, long-term investing, both in terms of generating return for the entity and also moving the ball forward on the charitable purpose.
23:23 - 23:50
So, like we talked about before, the board of trustees for a charity might say, you know, we're okay with a lesser return because we are through this investment providing some of the social, environmental change that we're hoping to produce as the purpose of the entity itself. So, I would say, look at sort of the needs of the entity. Then I would look at sort of the governing instruments and see if you can build in or address ESG as part of that.
23:50 - 24:24
Like I was mentioning with the settlers intent in the trust document or the Grantor's intent, you could expressly authorize ESG or address it in bylaws for the entity and an investment policy statement if the charity is created through a trust in the trust agreement. So, it's incredibly helpful for the Board of Trustees to think about how ESG investing might play a role for the entity in its beginnings or anytime you're revisiting those governing documents. And to do that beforehand so that they have a little bit more of a mandate in terms of how they can integrate it moving forward.
24:24 - 24:58
So, Jennifer, if you had to summarize how trustees and fiduciary should view the modern ESG as you described it, it sounds like you're saying these decision makers shouldn't be scared off by the label. Right. That they should essentially do the same type of analysis, comparison to other alternatives, comparison on costs that they would do for other traditional investments. With the caveat that for charitable organizations, you also have to look at, you know, how the investment may or may not fit with the mission.
24:58 - 25:45
I'd say that's fair. You know, I think that you're not prohibited from looking at ESG just because you're a fiduciary. The one thing I would note is that in today's marketplace, a lot of ESG strategies may be implemented in different ways, some more successful than others. So, I would also caution you not to look at ESG as some sort of silver bullet. It's all in how you do it. So, I think that fiduciary is much like they do with nanny issue strategies need to look at who is creating the strategy, how they're implementing it, what the index is. The historical performance has been and first and foremost, how it fits into how they're providing for the financial needs or in the charity's case, the mission of the beneficiaries. So, you know, I think that it is another tool in their tool belt and a really interesting one at that.
25:45 - 26:05
Yeah, I'm so glad you got to that point. Right. ESG is not a monolith. Just like saying that you're a value investor. There are a lot of different ways that portfolio managers employ a value investing. And so thank you for making that point. You really have to understand what it is. The ESG portfolio manager is trying to accomplish.
26:05 - 26:24
So I understand that this piece will be in the ABA Journal, maybe. Tell me tell us a little bit about that. And I know that when you wrote this piece, it was written so that it would be accessible to people like me who don't have a legal background. But maybe just tell us about where this piece will be appearing soon.
26:24 - 27:09
Sure. This is actually one of our first piece of long form research pieces and over a decade. So, Bernstein is actually self-publishing this piece, and it will be available in various ways through our financial advisors and other members of our team and through our website. But in addition to that, I'm really excited that it's actually going to be appearing in ABA Real Property Trusts and Estates Law Journal, their winter edition. That's going to be coming out in January. It's a terrific publication and one that I'm incredibly excited to be working with that produced this, and hopefully it will get exposure to all the right people to get even more folks talking about ESG investing and how those strategies interact with the legal field, specifically fiduciary law.
27:10 - 27:44
Jennifer, thank you very much for joining us. It's been a pleasure to get up to speed on all the great work you've been doing and looking at ESG and with fiduciary responsibility. This has been on purpose. Thank you for joining us. And remember, we all have values we hold dear. And now you can ensure, or rather, trustees can also ensure that your investments reflect them. You can reach me on LinkedIn. If you enjoyed the podcast, please rate us on Apple Podcasts, Spotify or your podcast service of choice. And be sure to subscribe. Thank you again.