ESG Investing: Theory, Evidence, and Fiduciary Principles
By Max M. Schanzenbach, Robert H. Sitkoff
Trustees and other investment fiduciaries of pensions, charities, and personal trusts, and those who advise them, face increasing pressure to rely on ESG factors in the investment management of tens of trillions of dollars of other people’s money. At the same time, however, confusion abounds about the intersection of fiduciary principles and ESG investing. This article cuts through that confusion to provide guidance about when and how ESG investing by trustees and investment fiduciaries is permissible. We make four interrelated points:
(1) we provide a clarifying taxonomy on the meaning of ESG investing, differentiating between risk-return ESG (i.e., using ESG factors to improve risk-adjusted returns) and collateral benefits ESG (i.e., using ESG factors for third-party effects);
(2) we discuss the subjectivity inherent to identifying and applying ESG factors, which complicates assessment of ESG investing strategies;
(3) we summarize the current theory and evidence on whether ESG investing can improve risk-adjusted returns, finding the results to be mixed and contextual; and
(4) we show that American trust fiduciary law generally prohibits collateral benefits ESG, but risk-return ESG can be permissible if supported by a reasoned and documented analysis that is updated periodically.
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