What is ESG Investing?

Many families have begun to express their family values not just through distribution standards or charitable donations, but through the investment strategy of family trusts. Focusing on a company’s environmental, social and governance impact on the world, families are attempting to align the trust investments with their personal values through the inclusion of specific language within their trust instruments expressly requesting that the trustees focus investment strategies on sustainable investments. This investment perspective is referred to as ESG investing. At its core, ESG investing is about using your financial resources to influence positive change in society by supporting companies which focus their business practices and core values on being the change.

What is ESG Investing?

ESG investing focuses on family values, sustainability, and the greater good. Families utilizing this strategy typically analyze companies in three areas: environmental impact, social impact, and governance values (ESG). The first, environmental impact looks at a company’s carbon footprint, its work in mitigating the emission of toxic chemicals in manufacturing, and its on-going pursuit of sustainable and eco-friendly supply chains.

The second area of impact is social. In this analysis, the investment is reviewed for the positive social impact the company is making both internally and in the surrounding community. Social change factors typically can include initiatives like LGBTQ+ engagement, racial diversity at all levels of the company, and inclusive hiring practices. It is a review of the company’s advocacy for social good not only from within, but also in the world around it.

The final area is that of company governance. In this area, company boards are reviewed for their ability to drive positive change through the company’s employment policies. This includes a review of whether the company has diversity in its leadership, how it manages its executive compensation, and how it interacts with its shareholders. It also includes a review of how effectively the company has implemented diversity, equity and inclusion principles into its corporate initiatives.

Effective ESG Implementation and Communication of Family Priorities

For new trusts, the path forward is simple, it is including specific language in your trust instrument either allowing or directing the fiduciary charged with investment discretion to focus investment strategies on ESG investments. This language can be broad, or very specific if the family values are focused on a particular area. 

In situations in which the family has very specific values that they wish to relay, an accompanying letter of wishes or family value statement can also be useful to the trustee. These secondary documents can include additional details and statements that might not be appropriate for a trust instrument for estate planning purposes. In that way, the family can provide background on why the family values focus on the specific area of change and what specifically they would like a trustee to look for when determining its investment strategy.

For existing trusts, the use of a letter of wishes or family value statement is the best way to convey family priorities regarding ESG investment. As this is still considered a more alternative investment strategy, a fiduciary will be looking for very specific guidance and the ability to understand the family’s goals. 

In some instances, a trustee may not be able to become comfortable with this type of investment strategy, for instance where grantor intent is unclear or the trust instrument creates an ambiguity as to the use of ESG investing. In that scenario, it may be necessary to utilize a non-judicial method of modification to conform the trust to the family’s value system and eliminate any lingering ambiguity within the trust instrument. After the settlor’s passing, where a letter of wishes or appropriate non-judicial modification method may be less available, the beneficiaries create a family value statement to ensure that the investment fiduciary of the trust understands the family’s goals and to promote ESG investing.

What Concerns Do Trustees Have?

A trustee’s inherent fiduciary duties of prudence and impartiality can be viewed as being at odds with ESG investment strategies. To understand this potential conflict, it is important to first understand these duties of the trustee. The duty of prudence requires a trustee to invest trust assets prudently, meaning conducting and documenting sufficient due diligence to determine the potential likelihood of success for the investment, provide for on-going monitoring, and a regular review of their returns. 

Historically, sustainable investments have yielded poorer returns than standard investment options, making them less prudent choices for an investment portfolio. However, as recently as December of 2023 some companies with strong ESG scores have been found to consistently outperform the S&P 500 Index over the past few years according to Forbes Magazine. This change in performance will help to mitigate claims that ESG investments are not prudent.

In addition, trustees have a fiduciary duty of impartiality. This duty requires a trustee to be loyal to both current and remainder beneficiaries in an equal manner. The duty of impartiality is applied not only to investing, but also to the administration and distribution of the trust. Where current and remainder beneficiaries have differing interests, impartiality requires the trustee to weigh the needs of both and find an equitable solution. 

The issue with ESG investing then, is finding a way to manage both group’s expectations with regard to what are acceptable sustainable investments. This is where a family value statement can be the most helpful. By providing a clear statement as to the family’s overall goals, a family value statement can help to make a trustee comfortable that it is achieving an equitable outcome that benefits and equally importantly satisfies all beneficiaries. 

To achieve this comfort, a family value statement should be careful to incorporate not only a consensus of the current beneficiaries, but also that it in some way incorporates the perspectives of the younger generation of current and remainder beneficiaries. In that way, the trust will be better able to achieve the family’s overall goals and promote its collective values. It is also important to reassess the family value statement periodically to ensure that it remains relevant and consistent with the family’s value system.

Commonwealth Trust Company is pleased to provide this article as a guide. Commonwealth Trust Company is not engaged in the practice of law and is not providing legal advice by the provision of these materials. Commonwealth Trust Company recommends that clients seek the opinion of their attorney regarding the specific legal and tax issues addressed in this article.