Pressure has grown on the asset management industry out of polarised viewpoints on whether ESG should or shouldn’t be included in investment decisions. On the surface this poses a dilemma for managers in how they perform their fiduciary duty.

Many are now asking the question – is ESG investing in line with fiduciary duty or simply using other people’s money to the pursue political aims? The origins and evolution of responsible investing can help us answer this. On the surface this has three parts.

First, investors wanting to invest in line with their values. Socially Responsible Investment (SRI) funds in their mandates avoided so-called “sin industries” such as tobacco, alcohol and gambling. Today, this has evolved to include other activities such as fossil fuels, deforestation and sustainable food systems, as well as positively investing in companies that deliver a positive social or environmental impact or that avoid doing such harm.

Second, at the turn of the century investors began to hold a greater focus on corporate governance following scandals such as at the Mirror Group. This increased appetite for responsible and active investor stewardship, holding companies’ boards to account as well as empowering them to take a longer-term view.

Third, the introduction of the Principles for Responsible Investment in 2006 increased acceptance in the investment industry that integrating all material considerations combined with unique insights derived from stewardship is an effective way to create wealth for investors over the long term. This includes integrating those issues related to ESG that had often been ignored by asset managers in the past, even when material. But no longer.

Through this lens, ESG investing has no trade-off with the fiduciary duty of an asset manager. In fact, ESG can be seen as executing on fiduciary duty.

ESG is often misunderstood

So, why has ESG been misunderstood – particularly over the past two years?

There has been a fundamental misconception that ESG is an entity in itself rather than categories of individual performance drivers, which manifest very distinctly in different industries and companies.

Governance should be seen as the organisation and processes that seeks to align all actors behind the long-term interests of the end investor. In turn, it governs a company’s business purpose and strategy, which then integrates the relevant and material environmental and social performance drivers. A company should pursue a business strategy that incorporates climate rather than a standalone climate strategy.

Further, relevant and material E, S and G issues are financial. They are not ‘non-financial’. And if not immediately financial, they may well be financial in the future. Depending on the business context, this includes the living wage, right to unionise, diversity and inclusion, carbon, biodiversity, bribery and corruption etc.

There is a misperception that to be considered material, E, S or G issues must be certain. However, of course, just like other performance drivers, outcomes are uncertain and investment managers will differ in their evaluations.

But that does not mean these issues should be ignored. As an example, a company should prepare for a 4.5 degree scenario as well as a 1.5 degree one. But it would be a doing a disservice to its investors and other stakeholders if it did not consider how it should operate if the economy moves to a net-zero world along a 1.5 degree path.

It has been argued that time horizons for E, S and G matters are different to most investment mandates. This was a concern I had when bringing investment managers and engagers together at company meetings.

However, my concern was unfounded. Both parties had similar objectives and an aligned and integrated agenda. Even with a three-year time horizon for an investment mandate, valuation can be seen inherently as a sum of future cashflows over a much longer period (the company’s business cycle and beyond). Further, it is evident that a strategy to achieve long term performance is often recognised in short-term valuations.

Asset managers have a duty to invest in line with the investment mandates provided by their clients. If the mandate requires thematic investment, then the fund manager should invest accordingly.

Otherwise, the role of an asset manager is to further the pecuniary interests of the investors who entrust their money to them.  This includes considering the material E, S and G factors alongside traditional performance drivers. Not doing so misses a key opportunity to create sustainable wealth for investors.