Practical analysis for investment professionals
21 September 2015

Sustainable Investing and Fiduciary Responsibility: Conflict or Confluence?

Do investors contravene or fulfill their fiduciary responsibility if they take sustainability into account in their investment decisions? And do they take it a step too far if they decide to divest from fossil fuels?

These issues are being passionately debated among investment professionals. One prominent investor with bold views on the subject is David Blood, co-founder of Generation Investment Management, former CEO of Goldman Sachs asset management, and a business partner of former US Vice President Al Gore. In this interview, he shares his views on fiduciary responsibility, sustainable investing, and fossil fuel divestment.

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CFA Institute: How do you describe sustainable investing?

David Blood: Sustainable investing is investing that integrates both long-term economic factors and environmental, social, and governance (ESG) factors. It’s about broadening your lens. It’s about analyzing more issues that are relevant and material. It is the explicit recognition that these factors impact the success of business. For example, how companies attract and retain employees, how they manage the risks and create opportunities from climate change matters to the success of the business. It is about managing risks and finding opportunities. It’s about enhanced analysis, and this enhanced analysis should enhance financial performance of long-term investments.

Why is there a perceived tension between sustainable investing and legal interpretations of an investment manager’s fiduciary duty to clients?

For some time, it was mistakenly assumed by many investors that sustainability was about moral values. Many thought that it was the same as traditional socially responsible investing (SRI) and that it was about negative screening businesses such as tobacco and ammunition. Since negative screening reduces investment choices, it supposedly hurts performance. Therefore, it was about trading economic value for moral values. That was what caused the tension between fiduciary duty and values-based negative screening. It’s an old tension based on outdated thinking. I have absolutely no problem with values-based negative screening. There will always be a place for traditional ethical investing but that is not sustainable investing.

Sustainable investing is about considering more issues in your investments rather than subtracting companies from your opportunity set. It is about finding opportunities and managing risks through enhanced analysis. Once you understand that this is about enhanced analysis and enhanced financial performance over the long term, then by definition it becomes your fiduciary duty to consider sustainability.

Ad for Sustainable, Responsible, and Impact Investing and Islamic Finance: Similarities and Differences

2015 meta-analysis by Arabesque Partners and the Smith School of Enterprise and the Environment at Oxford University shows that a clear majority of studies on financial performance and sustainability/ESG considerations reveal a positive association. Has such evidence informed the debate on fiduciary responsibility and sustainable investing?

Yes, such evidence is making a difference. It gives strength to the legal argument that fiduciary duty must consider sustainability. An increasing number of businesses and investors get that. But they aren’t the majority. The majority still confuses sustainable investing with old ways of negative screening based on moral values. This is more of a problem in the United States where sustainability gets mixed with politics. Some investors also confuse sustainable investing with green investing. Recently, a very senior person at one of the largest US asset managers asked me how is it that sustainable investing adds value if clean-tech has been unsuccessful. He has been an investor for some time, but he is still missing the point. We have come a long way on clarifying what is sustainable investing, but we have many more miles to go.

Because fiduciary duty is a legal concept, do you think legal developments regarding legislation and case law are needed to settle the debate on fiduciary duty and sustainable investing?

I think the legal debate is settled. We don’t need to worry too much about that. Now its about making the business case for sustainable investing. This is what we have been doing at Generation Investment Management for a number of years, explaining why sustainable investing and Sustainable Capitalism is best practice. Now we are pivoting our focus to explain how this can be done in practice to help people get on the same page.

There are different methods used to consider ESG issues. There are also asset classes other than listed equities in which sustainability is a consideration. Is there a need to enhance clarity on how to practice sustainable investing across asset classes?

It’s beginning to change. We are seeing conversations on ESG integration in fixed income, private equity, infrastructure, forestry, agriculture, even in hedge funds. It’s permeating all asset classes and investment frameworks. It’s pretty clear to most investors that there are limitations to negative screening. There is a place for best-in-class selection: It is being applied more in constructing sustainable indices. Active ownership makes sense no matter what asset class, and it is very consistent with how we practice sustainable investing. But yes, there is more work to be done on the “how to” of sustainable investing.

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What is your view on fossil fuel divestment in the context of fiduciary duty?

Let me make four points about carbon risk in general and then I will talk about coal and tar sands. First, all investors need to understand their carbon risk. That’s your fiduciary duty. Second, now that you understand your risks, decide if you need to engage with the companies you are invested in. If you are not sure of the carbon disclosure of an energy company you hold, you engage with the company to get information and understand that risk. Third, you diversify investments into opportunities positioned to succeed in a low-carbon economy. Fourth, you divest if you think the decision to hold carbon assets is not justified by the upside.

To be clear, there is no passive decision here. The decision to hold is an active decision. Holding an index with significant exposure to hydrocarbon is an active decision on risk. A number of pension funds have decided to reduce carbon exposure. You could do that through divestment from carbon assets or investment in a low carbon economy.

Now, moving to coal and tar sands investments, there is no reason for long-term investors to hold them. It’s just not worth the risk. One can trade around coal and tar sands: I’m certain some hedge funds will — some private equity funds may do so as well, trying to time when the risks will get fully priced in. Some of them will have the expertise to make that judgement. For others it will be a gamble. But for long-term investors, when they debate hold or divest coal or tar sands assets, the answer will be divest. It’s a no-brainer.

Recently, a Norwegian fund came under criticism for “pretend divestment.” What does divestment mean in practice? What do you sell and what do you keep? 

Divestment is both based on value and values. Let’s start with value-based divestment. In its easiest form, divestment means divesting from companies relying heavily on coal and tar sands. But what about utilities that rely on hydro-carbons or a mining company with a 5% revenue from coal? Fiduciary investors have to come up with a framework to think about the risk and return trade-off between “hold versus divest.” They need to reach a conclusion based on managing risk and finding opportunities and be ready to defend their position. Different investors will reach different conclusions. At our firm, we have done our analysis, we do not own hydro-carbon assets, and we have explained why.

You can also divest based on moral values, but that’s a different decision. I am not against divestment based on values, and it may well be suitable for some investors. But once you go down this path as a question of ethics — and we are not saying you shouldn’t — but it doesn’t make it easy. Indeed, it makes it harder since it widens the questions you need to answer.

How would you summarize your views on fiduciary duty, sustainable investing, and fossil fuel divestment?

Since sustainability drives the long-term success of businesses, it is the fiduciary duty of investors to integrate sustainability into their investments.

It is also the fiduciary duty of investors to understand the carbon risk of their portfolio, and your analysis could lead you to divestment from fossil fuels.

For more about sustainable investing and fiduciary duty from David Blood and Generation Foundation, see “Navigating Sustainability and Your Fiduciary Duty,” Allocating Capital for Long-Term Returns,” “Strong Economic Case for Coal Divestment,” and “Stranded Carbon Assets.”

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image credit: ©Getty Images / Ashley Cooper

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About the Author(s)
Usman Hayat, CFA

Usman Hayat, CFA, writes about sustainable, responsible, and impact investing and Islamic finance. He is the lead author of "Environmental, Social, and Governance Issues in Investing: A Guide for Investment Professionals;" the literature review, "Islamic Finance: Ethics, Concepts, Practice;" and the research report "Sustainable, Responsible, and Impact Investing and Islamic Finance: Similarities and Differences." He is interested in online learning and has directed three e-courses for CFA Institute: "ESG-100," "Islamic Finance Quiz," and "Residual Income Equity Valuation." The other topics he writes about are macroeconomics and behavioral finance. He has experience working in securities regulation and as an independent consultant. His qualifications include the CFA charter, the FRM designation, an MBA, and an MA in development economics. He has served as a content director at CFA Institute. He is a former executive director at the Securities and Exchange Commission of Pakistan (SECP) and former CEO of the Audit Oversight Board (Pakistan). His personal interests include reading and hiking.

5 thoughts on “Sustainable Investing and Fiduciary Responsibility: Conflict or Confluence?”

  1. When will someone acknowledge that ESG is active management and therefore markets are not efficiently pricing these factors. The discussion about active vs passive changes materially once we accept that active management is essential.

  2. Russell Campbell,

    Thanks for visiting our blog and sharing your comment.
    Indeed, it makes an interesting discussion whether and to what extent integrating ESG considerations can help generate alpha.
    Recently, when we surveyed members of CFA Institute on this topic, responding to the question “Why do you take ESG issues into consideration in your investment analysis/decisions?” the highest proportion of respondents (63%) selected “to help manage investment risks.”
    What David Blood is arguing is that integrating ESG analysis into long term economic analysis is about managing risks as well as finding opportunities, that is, it is about generating alpha.



    1. Thank you for your response. But I believe that ESG is not about alpha. It is redefining what we mean by beta. Beta becomes an index that is more than just a market cap weighted index.

  3. Ted Neild says:

    Your title posits an interesting question for investment committees and other fiduciaries. Unfortunately, you follow by interviewing a person whose entire business depends on answering this question in a particular manner. Unless you are a paid marketer for the firm, you might want to consider a counterpoint to provide us a more balanced perspective on the issue.

    1. Ted Neild

      Thanks for visiting the blog and sharing your point. Appreciated.
      That there must be a counter narrative to David’s view is a point that’s well taken. But isn’t always possible to bring out the counter narrative in a short interview format, there is barely enough room to explain one narrative.
      If you have thoughts on what is the counter narrative and how we can share the counter narrative on sustainable investing and fiduciary responsibility, I will be eager to know. Ofcourse, you are also welcome to share the counter narrative using this comments section.



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