INSIGHT: Can Trusts and Family Investment Companies be Ethical Investors?

Ethical, social and governance (ESG) factors are currently a hot topic in the investment world. There is increasing awareness and desire to ensure business and investment activities take ESG matters into consideration. Therefore, it is inevitable that people looking to establish estate planning vehicles are asking whether ESG factors can be hardwired into structures in relation to their investment portfolios.

Trusts and Family Investment Vehicles

Trusts, at least in the Anglo-Saxon world, are the go-to structure to facilitate estate planning. They allow legal and beneficial interests to be separated and have the flexibility required to fit a plethora of circumstances and wishes. Trusts work on the basis of the trustees’ fiduciary duties to act in the best interests of the beneficiaries. Therefore, whether ESG concerns can be taken into consideration or be the overriding concern when trustees are looking at investments they manage is not straightforward.

Family investment companies (FICs) are another estate planning vehicle which seem to be in vogue at the moment. FICs have no special legal status (in the U.K. at least).

FICs are just companies established for the purpose of meeting the needs of a family. The directors will often be the elders of the family with the shareholders being family members who are to benefit. The duties and powers of directors are different to those of trustees. Therefore, if, and to what extent, ESG issues can influence the decisions of the directors is not the same as the issues for trustees.

What is ESG?

There is increasing desire for people to invest in ethical and socially responsible companies. This is not merely refraining from investing in companies, for example, involved in the arms trade or animal testing. Things have moved on; wider factors are considered. Thus, an investment manager that is taking into consideration ESG factors might reject a company that makes wind turbines because of the huge pay gap between men and women employed there.

The question is whether ESG factors can play a part in a portfolio within a trust or FIC structure.

Trusts

The key issue with whether ESG considerations can be hardwired into a trust structure, or indeed any ESG considerations given, is what are the duties or powers of trustees when investing trust assets?

For the large part, the duties of trustees of an English law trust are set out in the Trustee Act 2000. Trustees generally have wide powers to invest as they think fit and are able to delegate their investment management function. However, they do have a number of duties when exercising their powers.

Trustees need to balance the interests of the different beneficiaries, considering their interests, circumstances and needs. The trustees also need to consider the trust fund as a whole and to act fairly between the beneficiaries, and not make decisions that would prejudice some beneficiaries. For example, if there is no life tenant and no immediate need to make distributions, the trustees may consider it appropriate to tell the investment manager to maximize capital at the expense of income. However, this would be wholly inappropriate where there was a life tenant.

The trustees have a primary duty, when selecting investments, to obtain the best financial return. Therefore, ESG considerations must come second to this duty.

It is often cited that incorporating ESG in investment decisions will mean in the long term that companies which score well in terms of ESG will be more sustainable and produce better returns than those that do not. However, there is a long-term horizon for this, as there may be other companies which do not score well in terms of ESG factors but produce a better return in the next five years. Making investment decisions with such a long-term horizon might not be appropriate in the circumstances.

What this all means is that the trustees cannot be compelled to invest funds with an ESG focus only as this would conflict with their duty to balance the interests of the different beneficiaries, act fairly and obtain the best financial return for beneficiaries.

This is not to say ESG factors cannot be taken into consideration. Where the trustees have considered all their duties, are content they are acting fairly and have balanced the beneficiaries’ needs, they can choose an ethical investment where it is of equal financial merit. A settlor’s wishes to take into consideration ESG factors, where possible, can be included in a letter of wishes.

FICs

With regards to FICs, the duties that the directors have to shareholders needs to be considered. Directors of English law companies have a number of duties and the core ones can be found in the Companies Act 2006.

One of the core duties is that directors need to promote the success of the company and they need to have regard to the following (section 172 of the Companies Act 2006):

• the likely consequences of any decision in the long term;
• the interests of the company’s employees;
• the need to foster the company’s business relationships with suppliers, customers and others;
• the impact of the company’s operations on the community and the environment;
• the desirability of the company maintaining a reputation for high standards of business conduct; and
• the need to act fairly as between members of the company.

A blanket approach to investing in companies that meet certain ESG criteria could not be regarded as acting in the best interests of the FIC as this may result in negative performance of the portfolio. However, the Companies Act 2006 clearly states that the long-term consequences and the impact of the operation of the FIC on the community and environment need to be taken into consideration.

Therefore, it may be easier for directors of FICs to incorporate ESG factors in the investment portfolio; although, as mentioned, this should not be to the detriment to the company as a whole which is arguably to maintain, protect and grow the family wealth that sits within the company.

As what is “ethical” evolves with time, the directors can also move with the times in investing or not in certain companies given the requirement to consider the community and environment is sufficiently broad.

Conclusion

Trustees or directors cannot make “ethical” investments only. Such an imposition goes against the fundamental principle that their duties cannot be fettered, and their core duties to beneficiaries (in the case of trusts) and shareholders (in the case of FICs).

This is not to say trustees and directors cannot make ethical decisions with regards to investments; this just needs to be one of the factors that they can consider.

Arguably, directors of an FIC may find it easier to incorporate ESG factors when investing, on account of the wide statutory meaning of “success” which means they have to consider the impact of the company’s operations of the community and environment.

Trustees will find it harder to follow the ethical path as this has to be subordinate to their other duties including obtaining the best financial results.

Hilesh Chavda is an Associate in the Private Wealth team at Royds Withy King. He can be reached by email: hilesh.chavda@roydswithyking.com

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.