Travers Smith's Sustainability Insights: Impact investments and fiduciary duties

A regular briefing for the alternative asset management industry.

At a conference discussing the Future of the Corporation organised by the British Academy last week, many speakers made an obvious point: all investment activity has impact. The right question, they said, is not whether a company has an impact on people and planet, but what the impact is. That is not a question that can go unanswered for much longer: companies that generate significant negative externalities are living on borrowed time. David Blood, co-Founder of Generation Investment Management, argued that all companies will soon be asked to report their impact, and asset owners and governments will hold them to account.

These messages sit well with a paper that Travers Smith co-authored last year for the Impact Investing Institute. The paper was aimed at UK pension fund trustees (to whom a specific legal regime applies) but it has important messages for any investor subject to fiduciary duties. It is well-known that fiduciaries must stay focused on the purposes and objectives that are given to them when they accept fiduciary responsibility: often to make appropriate risk-adjusted financial returns to meet the needs of the ultimate beneficiaries. But it is becoming clear that companies which give rise to significant negative impacts are likely to be higher risk – and may be expected to generate lower returns in the medium term. On the other hand, as stated in the Institute's paper, enterprises that actively benefit people and planet, and contribute to solutions to societal and environmental problems, "may provide opportunities for financial outperformance over the long term". Consideration of these issues as part of investment decision-making is certainly consistent with a fiduciary's duty.

As a matter of law, fiduciary duties are complex – and they are also continually shaped by the real-world circumstances in which they arise. It is clear, for example, that there are circumstances in which a fiduciary can, or even must, make investment decisions that are driven, in whole or in part, by non-financial considerations. That would be the case, for example, if the fiduciary's discretion is restricted in certain ways, or where non-financial considerations are specifically mandated by the fiduciary's legal remit or a clear expression of wishes by the ultimate beneficiaries.

However, for the trustees of UK occupational pension schemes, the legal ability to invest based on non-financial considerations is not clear-cut and trustees are generally on safer ground when their investment decisions are driven by financial factors. Relevant financial factors are wide-ranging: making appropriate returns at acceptable levels of risk, management of liquidity, and defining a time horizon that matches the liability profile of the scheme are all at the heart of the duty to act in the "best interests" of members.

...fiduciary-driven investors will increasingly be focusing on impacts – positive and negative – in the decades to come, and especially on the financial consequences of those impacts for their investments...

The Impact Investing Institute's paper argues that many impact factors have increasing relevance to these financial factors; for example, the avoidance of certain negative impacts by companies will, where relevant, be a financially material factor to be considered as part of the appraisal of an investment opportunity. Even impact factors that may not be financially material now could become so in the future, and so ought to be taken into account on that basis. And many "positive impact" funds may be regarded as providing new opportunities to make returns by investing in companies that help to solve the problems of the present and future. So, properly understood, impact investing is a strategy driven by considerations of financial risk and reward.

But the legal analysis does not end there. There are long-established principles in English law that trustee investment powers must be exercised "prudently", asking the correct questions and taking account of all relevant information. Against the background of the transition and physical risks posed by the climate emergency, and likely policy responses to other social and environmental concerns, impact factors will increasingly be an important consideration when fiduciaries think about what is prudent.

As we know, investors are increasingly demanding impact products, including many investors that may, in the past, have argued that impact investing was not compatible with their fiduciary duties. In fact, as the Impact Investing Institute's paper argues, fiduciary-driven investors will increasingly be focusing on impacts – positive and negative – in the decades to come, and especially on the financial consequences of those impacts for their investments. This creates an opportunity for a more sophisticated and holistic assessment of investments, which is consistent with obligations to beneficiaries and an integral part of fiduciary duty.

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