Trusts and ESG - fad or future?

17 December 2021 | Applicable law: England and Wales

This article was first published by eprivateclient on 8 December 2021.

ESG is moving from buzzword to mainstream. But against the backdrop of climate change and a pandemic that has exacerbated social inequalities, what does ESG mean for trusts?

For investors wishing to put their own money where their morals are, the decision to invest in environmental and socially responsible vehicles is straightforward. But what if you are investing someone else’s money?

The story so far…

Trustees have previously been wary of ESG, and with good reason. In the early days, the balance of risk and reward in ESG investments was not attractive. Rating and monitoring of credentials – as trustees are obliged to do – has also been difficult.

Trustees are duty-bound to act in the best interests of their beneficiaries (Cowan v Scargill [1985] Ch 270). That duty is been inextricably linked to investing – or instructing managers to invest – for the maximum financial return having regard to the trust’s risk profile.

The penalty for failure can be personal liability to make up the difference between the return achieved and that which the beneficiaries could reasonably have expected.

To add to the uncertainty, for trustees managing the views of different generations of beneficiaries, the problems presented by ESG can be serious.

For example, older beneficiaries’ views on appropriate investment and tolerable returns can conflict with the sensibilities of their younger companions. According to the Saltus Wealth Index, young investors in the UK (aged 18-24) are over three times as likely to invest in ESG, green and impact funds than older people (aged 65+).

That places trustees trying to manage and accommodate the interests and priorities of both groups in a difficult situation.

Against that backdrop, choosing to exchange financial return for environmental, social or sustainability gains has – in the past – been a bold move. And a move that many trustees have avoided, sometimes at considerable cost to the relationship between themselves and at least some of their beneficiaries.

Where are we now…?

The investment landscape is evolving though.

Initially, many ethical funds and other socially responsible investments appeared to have outperformed the market. For example, Accenture and the World Economic Forum found that companies that go above and beyond their peers to respect the environment and social issues generate at least 20 per cent more in profit.

However, the ESG revolution has recently faltered.

Critics dismiss ESG investing as a feel-good strategy unrelated to investment performance. Any outperformance of traditional funds has been described as a ‘mirage’, i.e. just enough to convince those who want to believe.

There follows the potential for greenwashing, a deceptive marketing practice that involves making unsubstantiated claims about an environmentally friendly product or service.

The hype around ESG has created an ‘anything goes’ mentality, including a lack of a standardised and recognised measurement system, which may hide material risks. So much so that the Financial Conduct Authority has recently published a paper on its new sustainability disclosure requirements, inviting views on potential criteria to classify and label investment products.

ESG has also become a revenue generator for asset managers, stock exchanges and credit rating agencies. ESG funds therefore tend to come with higher fees (even though they tend to overlap heavily with traditional funds).

What next…?

There is some comfort for trustees in the performance of ESG investments. It does seem that at least European ESG outperformance is the real deal. That steadiness gives trustees a strong platform for including at least some ethical investments in a trust portfolio which is focussed on security as well as growth.

Moreover, for trusts – and there are many – with investment horizons of 30 years or longer a focus on sustainable investments could well insulate trustees against changes of fashion in the financial markets.

That is not to say that introducing ESG to trust portfolios is now without complexity. Some trust deeds allow trustees more freedom than others. And not all ESG is created equal. What if an expensive ESG fund not only underperforms financially, but also sustainably? Caution is still required, as with all investment, but it is perhaps time for trustees to direct that caution towards the practicalities, rather than the principle, of ESG investment.

Turning to the practicalities:

Trustees must always check their powers of investment by looking at the trust deed.

If an appetite for ESG investing is identified as and when a new trust is established, drafting options can be included in the trust deed.

Trustees should also check and take advice on their Statement of Investment Policy Guidelines in order to ensure that it caters for ESG.

Trustees should ensure that any investments are carefully reviewed with the benefit of ESG-specific advice and appropriate action taken if advised.

Provided investment losses are not caused by trustees’ negligence, trustees should not be liable for any ESG investment losses provided they:

  • comply with the trust instrument and the statutory power of investment;
  • fulfil any relevant statutory duty of care (and indeed the trustees’ common law fiduciary duties);
  • act in the beneficiaries’ best interests (making investment decisions that are aligned with the beneficiaries’ ethics and morals could be considered to outweigh any financial consideration);
  • have a suitable Investment Policy which they review regularly;
  • operate a professionally-run portfolio which is regularly reviewed, as is the performance of investment managers.

In particular when exercising the power of investment with regard to ESG trustees should:

  • revisit any contemplated new investments to ensure they are still appropriate given the changes in the investment market and broader world;
  • review all trust investments more frequently than usually and consider whether they should be diversified / varied;
  • obtain appropriate advice if it is considered necessary to do so;
  • keep written records of consideration of any advice;
  • monitor performance of professional asset managers (including historic performance) and consider if intervention / change is required;
  • actively reach out to beneficiaries (rather than waiting to respond to questions) to address portfolio health and any action being taken to limit exposure.

It is difficult to see how a trustee, investing now in ESG with credentials and a proven track record, could be criticised (provided there are appropriate conversations, advice and monitoring). In that sense, trusts could lead the way and be a force for good in tackling ESG issues.

This document (and any information accessed through links in this document) is provided for information purposes only and does not constitute legal advice. Professional legal advice should be obtained before taking or refraining from any action as a result of the contents of this document.


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