The death of former South African President Nelson Mandela brought renewed attention to the divestment movement that Mr. Mandela himself credited with helping speed the end of the apartheid regime in his country.
The idea of divestment remains alive today. A number of public pension funds have sold their holdings in certain firearms manufacturers, following the lead of the California Teachers’ Retirement System. In Massachusetts, lawmakers are considering bills that would require state pension funds to shed stock in fossil fuel companies. Campus activists around the country are similarly urging university endowments to divest from oil, coal and gas.
But like their apartheid-era predecessors, these activists face criticism that divestment is economically ineffective and difficult to implement and, perhaps most significantly, that it forces investment trustees to violate their fiduciary duties to beneficiaries.
Future advocates for socially responsible investing may be able to overcome that fiduciary hurdle. In fact, they likely will argue that fiduciaries can hurt investment returns by ignoring the risks posed by owning stock in companies with poor environmental, social and corporate governance – or “ESG” – practices.
Retirement-plan fiduciaries, no matter their political sympathies, are duty bound to act in the best interests of current and future beneficiaries. Among many other things, fiduciaries must make decisions aimed at achieving investment returns that will enable payment of benefits many years into the future.
“The endowment is a resource, not an instrument to impel social or political change,” Harvard University President Drew Gilpin Faust said in a statement arguing against divestment from fossil fuel.” Significantly constraining investment options risks significantly constraining investment returns.”
For more than a decade, a loose coalition of investors, academics and investment professionals has been working to turn consideration of ESG factors from a fiduciary liability to a benefit. Rather than “screening” portfolios to exclude certain types of stocks, they believe investors should expand their risk assessments to include potential fallout from investing in companies with poor ESG practices.
This shift toward framing ESG investing as a tool for maximizing returns not only comports with activists’ firmly held beliefs, it reflects a new, but broadly-held line of thinking that consideration of such factors in fact aids investment performance. Framing the argument that way benefits pro-ESG advocates by demonstrably bringing their beliefs in line with fiduciary obligations.
Underpinning this approach are legal and financial studies that say, first, that considering ESG is permitted under fiduciary standards and, second, that doing so could actually boost investment returns. These findings are summarized in an ongoing series of reports issued by the Asset Management Working Group (AMWG) of the United Nations Environment Program Finance Initiative.
“The first – and arguably for investors the most important – reason to integrate ESG issues is, simply, to make more money,” the AMWG said in the 2006 study Follow the Money. “There is a hypothesis, which we support, that a more thoroughgoing and systematic approach to integrating ESG issues in portfolios will, over time and in general, result in better financial performance.”
The 2005 Freshfields Report issued by the same group concluded that in the United States and eight other countries “ESG considerations may be taken into account as long as they are motivated by proper purposes and do not adversely affect the financial performance of the entire portfolio.”
Freshfields argued that “integrating ESG considerations into an investment analysis so as to more reliably predict financial performance is clearly permissible and arguably required in all jurisdictions.”
A 2009 AMWG report, dubbed Fiduciary II, went further, concluding that “the global economy has now reached the point where ESG issues are a critical consideration for all institutional investments and their agents.” Fiduciary II raised the notion that investment advisors had a duty of care to discuss ESG factors with their clients or face potential liability for failing to do so.
Such views have not yet been accepted by the majority of investors in the United States or even in Europe, where ESG advocates have made far greater inroads. Before that happens, investors and their advisors will need to answer a lot of practical questions, such as how to create tools that objectively and accurately allow them to evaluate ESG risk and integrate it into decision-making.
While ESG’s acceptance by mainstream investors is not a foregone conclusion, the tide continues to turn in its favor. To date, more than 1,200 asset owners, investment managers and professional services partners have signed the United Nations’ Principles for Responsible Investment, pledging to “incorporate ESG issues into investment analysis and decision-making processes.” The signatories – a who’s who of finance from around the world – are the clearest demonstration of just how far the ESG movement has progressed.