Fiduciary duty forms the bedrock of overseeing someone else’s money.
Generally extended to members of boards of trustees and directors as well as investment committees and discretionary investment advisors, this responsibility requires that investment decisions are always made in the best interest of the foundation. Anything less is a breach of fiduciary duty, which can lead to serious legal consequences.
For many years, this fiduciary commitment tempered enthusiasm for socially responsible investing (SRI) among foundations. Some held concerns that SRI detracted from financial returns, particularly if an investment portfolio excluded certain companies or even industries such as tobacco, gambling, or fossil fuels. The resulting performance deviations from this investment approach could be perceived as a failure to meet fiduciary obligations.
Yet as the foundation community grows to understand the potential ripple effects of mission-aligned investments, the tide has begun turning toward a wider acceptance of investments that generate results broader than the bottom line.
The evolution of data availability positions investors to tilt toward companies with relatively responsible environmental, social, and governance (ESG) practices without actively excluding others from a portfolio. This notion of positive screening has been shown to produce relatively competitive performance as well as support ESG efforts.
Fiduciary Duty for Foundations
At the core of every foundation, there is an endowment that allows the organization to fulfill its vision and mission through grants to worthy recipients such as nonprofits and nongovernmental organizations.
Internal Revenue Service guidelines dictate that private foundations distribute 5% of their assets every year. In order to support their vision and mission, most organizations enlist professional investment managers to grow the remaining 95% and maintain the viability of the foundation.
Fiduciary duties require acting in good faith and in ways that a prudent and rational individual would act. These duties are defined by two legal doctrines: the Uniform Prudent Management of Institutional Funds Act and the Uniform Prudent Investor Act. The acts also allow for a number of outside factors that could affect an investment’s return, including inflationary and deflationary impacts, tax implications, the broader economic landscape, and the relationship to the foundation’s vision and mission.
Ultimately, holding a foundation’s investment committee and board of trustees to the fiduciary standard allows the organization to keep making grants, anticipate potential capital needs, and cover core functions such as operational, marketing, and fundraising expenses.
Emerging Legal Perspectives
The shift in thinking on performance also stems in part from the active back-and-forth over ESG investing’s place in the fiduciary standard. In the 2020 Fiduciary Duty in the 21st Century, the Principles for Responsible Investment and UN Environment Programme Finance Initiative declared that investors must incorporate ESG issues into their investment analysis and decision-making processes. The authors supported their conclusion by citing the emergence of ESG analysis as a standard, the financial materiality of ESG factors, and policy and regulatory shifts.
Meanwhile, a Stanford Law Review article published in February 2020 concluded that ESG investing does not violate US trust law as long as trustees see the approach as improving risk-adjusted investment returns. The article also states that enhanced return potential is the sole rationale for ESG integration. Although this thinking allows some latitude, it stops short of agreeing that ESG analysis should be mandatory.
Conversely, a University of Colorado Law Review article published less than a year earlier contended that the evolution of the standard of prudence increasingly allows for the use of information traditionally ignored by investors. Therefore, ESG analysis should be a piece of the fiduciary standard.
Notwithstanding the legal wrangling, the Forum for Sustainable and Responsible Investment reported in its 2020 US SIF Trends Report that 126 foundations incorporated ESG factors into their investment decisions on $97 billion worth of assets. This is a 43% increase above the level reported two years prior.
Although the debate over fiduciary duties will undoubtedly continue, the growing awareness of the beneficial outcomes of impact investing could render the discussion moot for many foundations and inspire wider adoption.