New academic paper rejects role of ESG in fiduciary duty

A new academic paper has rejected the idea put forward by the Principles for Responsible Investment (PRI) and others that a fiduciary must consider environmental, social and governance (ESG) factors, and that the failure to do so is a breach of duty.

The paper challenges what it calls the “current zeitgeist” around the soundness of ESG — but the PRI said it needs to “go one step further”.

“Crucially, nothing in the law or economics of ESG investing requires a fiduciary to use ESG factors,” write law professors Max Schanzenbach and Robert Sitkoff. Schanzenbach is with Northwestern University while Sitkoff – a consultant to Hermes Investment Management’s new owner Federated Investors – is at Harvard.

“To the contrary, both passive and contrarian investment strategies are also permissible and likewise find support in the financial economics literature.

“Thus, as we shall see, a trustee or other investment fiduciary could justify a contrarian, anti-ESG investing strategy on the same conceptual and economic logic that the PRI and others have invoked in support of ESG investing.

“Accordingly, we reject the view taken by the PRI and others that a fiduciary must consider ESG factors, and that the failure to do so is a breach of duty.”

The add: “Our findings challenge the current zeitgeist in favor of the soundness of ESG investing by a fiduciary, in particular many of the arguments and conclusions of the PRI.” The authors erroneously refer to the PRI as the Principles for Responsible Investing.

Their paper is called The Law and Economics of Environmental, Social, and Governance Investing by a Fiduciary.

They say ESG “resists precise definition” and their paper comes amid “a backdrop about both the law and the economics of ESG investing”.They coin two terms: “collateral benefits ESG” (i.e. for moral and ethical reasons and “risk-return ESG” (to improve returns). While the latter can be consistent with fiduciary duty but is not required by it, the former, it’s argued, “is generally not consistent with fiduciary duty”.

The pair write: “The PRI and others have argued that the evidence in favor of risk-return ESG investing is so overwhelming that it should be required by the duty of care.

“We reject the view taken by the PRI and others that a fiduciary must consider ESG factors”

“Our review of the theory and evidence suggests that the picture is much more mixed, and furthermore there is no guarantee that a favorable result for any particular risk-return ESG investing strategy will persist over time. To the contrary, as an investment method becomes widely adopted, the possibility that it will generate excess returns diminishes.”

The PRI said the research doesn’t go far enough.

“We are pleased to see research on the relationship between ESG issues and fiduciary duty, particularly focusing on the US market. We welcome the finding that ESG issues can be incorporated as part of an investor’s fiduciary duty, however, we believe the research needs to go one step further,” said PRI head of policy Will Martindale.

“The PRI finds overwhelming evidence that demonstrates that ESG analysis can assist investors to better manage risk and return. We therefore believe that the consideration of ESG factors has become one of the core characteristics of a prudent investment process and that failing to integrate ESG issues is a failure of fiduciary duty.”