The principles of responsible investment – a short series. The opening clause

Yesterday we introduced the UN’s Principles of Responsible Investment. In today’s article, we look at the opening clause.

The opening clause of UNPRI states that, “As institutional investors, we have a duty to act in the best long-term interests of our beneficiaries. In this fiduciary role, we believe that environmental, social, and corporate governance (ESG) issues can affect the performance of investment portfolios (to varying degrees across companies, sectors, regions, asset classes and through time). We also recognise that applying these Principles may better align investors with broader objectives of society. Therefore, where consistent with our fiduciary responsibilities, we commit to the following:”

Every fund manager within an institutional investor has a mandate (a set of permissions) to invest in certain sectors and territories, at certain levels of exposure, with an expectation of a certain range of return. A fund manager has no freedom to operate outside that mandate and therefore the opening clause sets out this ‘duty to act’ in the interest of the beneficiaries.

What strikes us about this opening sentence is that it is the long-term, over the short-term interest, that is the priority. Climate change, resource scarcity and environmental degradation will all have massive long-term, strategic and underestimated implications for every industry and every country. From the opening sentence, these principles challenge the sometimes prevailing short-term thinking of many investment strategies.

The opening clause goes on to drive this home with the observation that ESG issues can affect performance.  On a long-term basis, we would go as far to say that ESG issues will categorically affect performance. While the impact will indeed be of ‘varying degrees’, the overall impact of severe climate change, resource scarcity and environmental degradation will be profound and massively disruptive.

Fiduciary roles and responsibilities simply means ‘holding in trust’, for the purpose of profit, as that is what an institutional investor does with an investor’s money. It’s an interesting word derived from the Latin for faith (fides) and trust (fiducia). It is a legal and ethical relationship between two or more people. Indeed, we all have a fiduciary role with our planet and society, such that we leave it in a state that is viable for the following generations.  A Native American proverb says that, “we do not inherit the earth from our ancestors, but we borrow it from our children.” Sadly, as a species we are acting more like a hard-living, profligate, privileged predecessor who leaves nothing but debt, hardship and misery to their children. ‘Sorry but there’s no money left’, is the message our generation is leaving the next.

Aligning investors with the broader objectives of society opens a huge can of worms, or nest of vipers, as there seems to be little agreement on what those objectives are.  Is society’s objective the maintenance of harmony, law and order, wealth generation, protecting the vulnerable, equality of opportunity or the pursuit of happiness, or some variable combination of them all? The societal objectives of our own country differ widely internally and with our continental neighbours, never mind the differences between established and emerging economies, and entirely different cultural heritages in Asia. With the many scandals in financial services, fraud, record salaries/bonuses for failure and the nationalisation of losses, investors could not be more misaligned with any of the broader objectives of society. Currently there is widespread disharmony, lawlessness, wealth destruction, harm of the vulnerable, inequality and misery

The final ‘where consistent with fiduciary responsibilities’ is the necessary catch all that allows the widest possible participation by institutional investors. If the mandate is to maximise profit from the arms industry and child labour then that is their fiduciary responsibility. Yesterday we made the point that while purists may moan, the principles need to be aspirational and voluntary and similarly we would stress that any international agreement needs to have a catch-all clause that opens access rather than closes it. Only through positive engagement can progress be achieved. Organisations that sign up to the principles commit to further actions in analysis, ownership, disclosure, promotion, collaboration and reporting that will nudge fiduciary responsibilities over time.

As climate change, resource scarcity and environmental degradation become more pronounced, and society become more unstable as a result, it will be apparent that fiduciary responsibility and long-term interests coalesce around responsible and sustainable investment. Our fervent hope is such behavioural change does not come too late.

Tomorrow we will be looking at the first principle of incorporating ESG into investment analysis and decision-making.

Further Reading

The principles of responsible investment – a short series. An introduction.

Encouraging sustainable finance: the principles for responsible investment

The Guide to Sustainable Investment 2012