Investment managers agree that Environmental, Social and Governance (ESG) criteria affect shareholder value both in the short- and long-term. ESG criteria affect both company risk and return. Investment managers claim to have successfully employed ESG criteria to thereby reduce the risk of client portfolios and to improve the quality of returns.

If research has shown ESG criteria to reduce risk and improve returns, why are investors still reluctant to incorporate ESG criteria into their investment strategy? GraySwan has identified the following reasons for the slow uptake of ESG criteria by investors.


Legal role of the fiduciary

A major issue raised by Trustees is how ‘responsible investment’ and ESG issues relate to the fiduciary duty of Trustees.

Pension Fund Trustees do not have one single ‘fiduciary duty’ but rather a number of distinct duties including to act in the best interest of all members, to treat all beneficiaries impartially and to avoid (rather than to manage) conflicts of interest. Yet conventional understanding view ‘fiduciary duty’ as a single “duty to maximise returns”.

Fiduciary duty exists to ensure that those who manage other people’s money act responsibly in the interests of investors, rather than serving their own interests. Yet interpretations of this crucial legal principle appear increasingly dysfunctional. Fiduciary duty is frequently invoked to justify a fixation on maximising short-term returns while in reality returns are stagnating while fees paid to service providers are high and conflicts of interest escalate within the business model of these service providers.

Responsible investment offers the opportunity to rethink fiduciary duty in light of long-term, sustainable returns, although this may challenge conventional thinking.

Time Horizon

The fixation on maximising returns in turn compounds the problem of short-termism in the investment process. Extending the time horizon may increase the range of available investment vehicles and may enhance returns.

Investment theory and beliefs

Investors base their investment strategies on conventional portfolio theory and many times rely on short-term measures of investment performance. Discussions on ESG issues remain an after-thought.

The financial crisis has caused investors to call into question core beliefs about how markets function and conventional investment wisdom. For instance, the conventional risk and return approach does not seem to match up with recent investment experience, as diversification could not protect portfolios against the financial crisis. Many investors have found the crisis leading them to revisit Modern Portfolio Theory and how it guides their investment strategies.

Further, the duty to invest prudently is understood by reference to the prudent investor rule: fiduciaries must “take such care as an ordinary prudent man would take if he were minded to make an investment for the benefit of other people for whom he felt morally bound to provide”.

This particularly makes Trustees fearful of departing from established investment orthodoxy and make the industry as a whole slow to evolve. Pension funds may not wish to ‘jump first’ and adopt innovative strategies that are out of step with their peers, since this could leave them exposed to perceived charges of imprudence. 

Broader Economy

Narrow interpretations of ‘financial interests’ also neglect factors affecting beneficiaries’ broader economic wellbeing. Investors have an interest in the stability and strength of the economy, yet under the prevailing interpretations of ‘fiduciary duty’ Trustees typically simply seek the best returns wherever these are to be achieved.

The performance of the economy as a whole will ultimately be a far greater determinant of the size of the average investor’s pension pot than the extent to which their pension fund or investment portfolio outperforms the market. The health of the economy as a whole affects the “market” that the pension fund or investment portfolio performs within. In addition the economy as a whole affects investors’ employment and salaries and therefore contributions and years of service which directly affect the size of the final pension pot. There is therefore a good case to be made for socially responsible investing in the fund’s home country.

Recommended actions:

Investor empowerment

Investors and Trustees need to be educated and trained in order to empower them to make informed decisions relating to responsible investment and how it fits into their long term investment strategy.

Extending time horizons

Investors are currently plagued by short-termism. A culture of longer term time horizons should be embedded within their decision making framework.

Investment in the broader economy

The growth of financial products and services do not necessarily translate into robust economic activity. The health of pension funds and investor portfolios, over the long term, is closely linked to the health of the economy as a whole. This involves rethinking how investors and especially large pension funds measure their contribution to economic activity, and how social and environmental changes affect long-term performance. The Trustees should also keep the needs of beneficiaries in mind, whose lives are directly affected by the state of the economy.


  1. Initiative for Responsible Investment. David Wood and Jay Youngdahl. September 2011. Public Pension Fund Trustees and Fund Culture: Responsible Investment and the Trustee Leadership Forum.
  2. UNEP Finance Initiative. October 2012. Creating the “New Normal”: Enabling the Financial Sector to Work for Sustainable Development.
  3. FairPensions. October 2012. The Enlightened Shareholder: Clarifying investors’ fiduciary duties.