Climate Change

On Monday, the Intergovernmental Panel on Climate Change (IPCC) released their third report which warned that the world only has a narrow chance of limiting global warming to 1.5C above pre-industrial levels. The report explained that overshooting 1.5C was, “almost inevitable” but that, if drastic action was taken this decade, this overshoot might only be temporary and temperatures could be returned to 1.5C by the end of the century.

The conclusion of the report is that all countries need to reduce their greenhouse gas emissions drastically by 2030 and the world needs to reach net zero emissions by 2050. This means changing the way we live in terms of our energy, buildings, transport, food and industry.

As investors, this presents great opportunities as well as huge potential risks. So let’s look at this from the perspective of a trustee managing assets on behalf of potential beneficiaries.

We know that trustees have a number of duties they have to perform as laid down by the Trustee Act 2000.

Trustee Act 2000

Essentially, the Trustee Act 2000 modernized the law relating to the powers and duties of trustees and created a statutory duty of care. The Act also gave trustees a wider power of investment. The key sections are:

Section 1 - a trustee must exercise such care and skill as is reasonable in all circumstances, taking account of any special skills or knowledge that he/she may have.

Section 3 – trustees have a general power to deal with trust property as if it were their own.

Section 4 – a trustee must, from time to time, review the investments of the trust and consider whether they should be varied. The standard investment criteria looks at the suitability to the trust of the investments chosen and whether there is a need to investment diversification.

Section 5 – before exercising any power of investment, a trustee must (unless it is inappropriate or unnecessary) obtain proper advice with due regard to the investment criteria.

Risk - Return - Impact

Many trustees and their advisers are familiar with the concept of risk and return but how many consider the impact of the investments they make on behalf of the beneficiaries? As the IPCC report highlights, we need to tackle climate change this decade if we have any chance of keeping global temperatures down below 1.5C this century. Therefore, if trustees don’t consider how their investment decisions may impact climate change, we run the risk that future generations inherit a world where large parts are uninhabitable or impacted by civil unrest.

In our view risk, return and impact go hand-in-hand. Data suggests that those companies that take their Environmental, Social and Governance (ESG) responsibilities seriously exhibit lower risk than companies who don’t or who have poor ESG scores.

Data also suggests that taking ESG factors into account does not negatively impact performance.

The Office for National Statistics estimated that there was around £2.2 trillion invested in pensions at the end of 2019. If we add assets held outside of pensions, it is clear that there is a huge amount of money that could be used to achieve a positive social and environmental impact. This impact could involve excluding tobacco companies whose products result in the deaths of millions of people or avoiding companies that pollute the environment. It could mean investing in renewable energy or social housing or just investing in companies that take their ESG responsibilities seriously and avoiding those that don’t. The positive impact our investment choices can have are enormous.

So if investing responsibly reduces risk, doesn’t negatively impact returns and has a positive social and environmental impact why wouldn’t trustees adopt a responsible investment approach? This was a question that was addressed in the Freshfield Report commissioned by the UN in 2005.

The Freshfields Report

The report produced by Freshfields Bruckhaus Deringer in October 2005 looked at whether a trustee could take into account ESG – Environmental, Social and Governance – criteria when looking to invest the assets of a Trust.

At the time of the report there was some uncertainty as to whether a trustee’s fiduciary duty meant that they had to invest the assets of a trust to produce the optimum financial return. The misconception at the time was that applying an ‘ethical’ criteria to the underlying investment strategy would narrow the investment universe thereby reducing the benefits of diversification which could lead to lower returns. In other words, the sole duty of a trustee was simply to maximise returns.

The Freshfields report concluded that ESG factors should be considered when investing the assets of a trust, given that there was a link between ESG factors and financial performance and also where ESG factors were a reflection of the values of the beneficiaries.

The Freshfields report acknowledged that, in carrying out their fiduciary duties, trustees should take into account the fact that social norms and values change as does the investment industry which has seen a greater understanding of how ESG issues affect investment.

The Development of ESG

Since the Freshfields report was written in 2005, there is now much more awareness of climate change and other social issues and how these impact everyone globally. More and more people are beginning to acknowledge that simply making profits at the expense of people and the planet is outdated and needs to change. More and more consumers are making decisions about where they shop based on whether their values are aligned.

Investing Responsibly

Putting in place a responsible investment strategy can be challenging - the investment industry uses lots of different terminology such as ‘ethical’, ‘sustainable’, ‘ESG’, Impact’ or ‘Green’ investments, all of which can mean different things.

We work with trustees to help them cut through this jargon and identify the impact they wish to make with their investment strategy.

We believe that there are potential investment opportunities over the next decade or more as the world transitions to net zero emissions, as new technologies are invented and new markets opened up. We also believe that significant risks exist if investors continue to fund industries that damage or pollute the environment both in terms of investment performance as well as the impact on the planet.

Conclusion

We believe that trustees have a fiduciary duty to take into account risk, return and impact when managing Trust assets. We know it can be challenging given the plethora of ‘ethical’ funds available, however, trustees need to be mindful of the legacy they leave for future generations - climate change is not something that is on the distant horizon but something that is happening as we speak and action must be taken sooner rather than later.

If you would like to discuss implementing a responsible investment strategy, please do contact us.

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Trusts - Why Trustees Should Invest Responsibly