Jessica Jarvis

In today’s investment landscape, trustees are increasingly under pressure to integrate Environmental, Social, and Governance (ESG) factors into their investment strategies. Beneficiaries, regulators, and the broader public are demanding that investments not only deliver financial returns but also align with ethical and sustainable practices. For trustees of private and charitable trusts, the question is how to balance these ESG objectives with their fundamental fiduciary duties.

This guide explores the legal framework underpinning trustee investment decisions, the practical challenges of ESG integration, and best practices to future-proof investment strategies.

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Legal Framework

Trustee Act 2000

The Trustee Act 2000 is the cornerstone of trustees’ investment responsibilities in England and Wales. It sets out the duty of care that trustees must exercise and introduces the standard investment criteria, which require trustees to:

1. Consider the suitability of investments.
2. Diversify investments as appropriate.

Trustees are obligated to act prudently and in the best interests of the beneficiaries, focusing on the preservation and enhancement of trust assets.

Charity Commission Guidance (CC14: Investment of Charitable Funds)

Although aimed at charitable trustees, the Charity Commission’s guidance is persuasive in setting expectations for ethical investment practices. It clarifies that:

• Trustees can make ethical investments where:
  • They conflict with the trust’s objectives.
  • They might alienate beneficiaries or supporters.
  • They have no significant risk of financial detriment.

This guidance supports the idea that ethical considerations can be taken into account, provided they do not compromise the trustee’s duty to maximise returns.

Cowan v Scargill [1985] Ch 270 (Key Case Law)

This case remains a leading authority on fiduciary duties and investment decisions. The court held that trustees must put aside their own ethical views and focus on the financial interests of beneficiaries.

However, subsequent legal thinking and guidance (including CC14) suggest that ESG factors can be considered as part of a prudent investment strategy, particularly where:

• ESG risks could affect financial performance.
• Beneficiaries have a shared interest in ethical investments.

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Challenges for Trustees Integrating ESG Principles

1. Defining Beneficiaries’ Best Interests

One of the most complex challenges for trustees is defining and interpreting the “best interests” of beneficiaries when ESG factors are introduced. Beneficiaries often have varying ethical priorities and investment philosophies. For example:

• Some beneficiaries may prioritise environmental sustainability, supporting investments in renewable energy or companies with strong environmental policies.
• Others may prefer focusing on traditional investment opportunities that promise higher financial returns, regardless of ESG impact.
• There may also be inter-generational differences in expectations, with younger beneficiaries favouring progressive ESG policies while older generations may have a more conservative view.

Trustees have a duty to act impartially between beneficiaries and cannot favour one view over another unless:

• The trust deed explicitly directs an ESG approach.
• There is a consensus among beneficiaries that supports an ESG-aligned investment strategy.

Failure to balance these divergent interests could expose trustees to disputes or allegations of breaching their duty of impartiality.

2. Balancing Performance and Principles

The perception that ESG investing requires sacrificing financial returns is gradually shifting, but it remains a concern. While some studies suggest ESG-focused investments can outperform traditional investments in the long term, the results are not universal across all asset classes or timeframes.

Trustees face key questions:

• Will the ESG investment portfolio deliver returns that are in line with or exceed those from a conventional investment strategy?
• Could excluding certain industries (such as fossil fuels, defense, or tobacco) lead to a material reduction in diversification and potential returns?

Trustees must weigh these factors carefully, ensuring that ethical considerations do not override the fundamental duty to preserve and enhance the trust’s financial resources unless they can demonstrate that:

• ESG risks (such as regulatory change, reputational risk, or environmental liabilities) pose a genuine threat to financial performance.
• Beneficiaries have expressly agreed to prioritise ESG objectives.

3. Due Diligence and Investment Selection

The rise of ESG investing has led to a proliferation of funds and products claiming strong ESG credentials. However, not all of these offerings withstand scrutiny. Trustees must navigate several challenges in conducting effective due diligence:

• Greenwashing: This occurs when investment funds or companies exaggerate or misrepresent their ESG commitments. Trustees need to ensure that the claims made by investment managers are backed by robust data and transparent methodologies.
• Lack of Standardisation: ESG ratings and metrics can vary significantly between different providers. A company rated highly by one ESG ratings agency may score poorly by another.
• Evolving Standards: ESG is a rapidly developing field. Trustees must keep up with changing benchmarks, regulations, and stakeholder expectations.

Effective due diligence requires:

• Engaging with investment managers who can clearly articulate their ESG process and demonstrate how ESG factors are integrated into financial decision-making.
• Reviewing independent third-party ESG ratings and reports.
• Regularly reassessing ESG investments to ensure they continue to meet both ethical and financial standards.

Best Practices

1. Policy Development

Trustees should adopt a written ethical investment policy that:

• Clearly articulates the trust’s position on ESG factors.
• Sets parameters for acceptable and unacceptable investments.
• Is approved and reviewed by all trustees.

This policy should be aligned with the trust’s objectives and the best interests of beneficiaries.

2. Stakeholder Engagement

Where appropriate, trustees should consult with beneficiaries to understand their ESG preferences. This can:

• Help trustees act in beneficiaries’ collective best interests.
• Reduce the risk of future disputes over investment decisions.

Documentation of stakeholder consultations should be retained as evidence of prudent decision-making.

3. Ongoing Monitoring and Review

ESG is an evolving field. Trustees should:

• Regularly review the performance and ESG credentials of their investments.
• Update their investment policy to reflect regulatory changes, market developments, or beneficiary feedback.
• Seek advice from qualified investment advisers with ESG expertise.

Trustees can integrate ESG goals into their investment strategies without breaching their fiduciary duties – provided they act prudently, transparently, and in line with beneficiaries’ best interests.

By developing clear policies, engaging stakeholders, and conducting rigorous due diligence, trustees can achieve an investment approach that balances ethical responsibility with financial stewardship.