Should maximizing financial returns be the sole consideration when financial advisors choose investments for their clients’ retirement plans?
The passage of Florida’s “Anti-ESG” bill in May has spotlighted this national debate, one with potentially serious implications for investment advisors with environmental, social, and governance offerings. “We want [state fund managers] to act as fiduciaries,” Gov. Ron DeSantis was widely quoted as saying before he signed the bill into law. “We do not want them engaged on these ideological...
Should maximizing financial returns be the sole consideration when financial advisors choose investments for their clients’ retirement plans?
The passage of Florida’s “Anti-ESG” bill in May has spotlighted this national debate, one with potentially serious implications for investment advisors with environmental, social, and governance offerings. “We want [state fund managers] to act as fiduciaries,” Gov. Ron DeSantis was widely quoted as saying before he signed the bill into law. “We do not want them engaged on these ideological joyrides.”
But is that what the ESG industry is doing?
Whether you take a close look at those clamoring to uphold traditional capitalistic values or at the major companies that emphasize ESG investing—including a prominent manager that has become a target of Republican politicians—you’ll see that their disagreement is not over whether, but which, exclusively financial risks should be considered.
As ESG-rater MSCI itself says, such ratings are “not a general measure of corporate ‘goodness.’” Rather, they are “designed to look at the financial significance of ESG issues.” For instance, a company that moves its factory from the coast to higher ground in order to avoid flooding due to rising sea levels could see improvement in the “E” component of its rating even if it isn’t taking steps to mitigate climate change.
So the great ESG debate, in the end, is not much of a debate at all. At least not yet.
The real debate to be had by the financial-services industry is not about whether a callous corporate strategy will be more financially successful than a kind one, but about what it really means to be a fiduciary and take care of investors’ interests.
Do you believe that what goes around comes around? If so, companies should enact policies that are kind to employees, customers, and society, with the expectation that those constituencies will reciprocate this kindness with loyalty. Employees will go above and beyond for the firm, customers will stick around and tell their friends, and society will not slap the company with regulations and fines. The logical conclusion of this argument is where kindness takes root, financial performance will follow. This emphasis on a stakeholder-focused style of capitalism suggests that ethical issues can and should be considered during the investment process. This makes sense to me.
On the other hand, if you believe that nice guys finish last, then companies should be as rapacious as possible in their pursuit of squeezing out every extra cent in profit, and that advisors should not allow ethical issues to factor into their investment analysis. Put in these stark terms, that’s a hard philosophy to stomach.
A different lens. When looked at from a fiduciary perspective, a different conversation emerges. The fiduciary legal concept was originally intended to prevent agents like investment advisors and retirement plan providers from acting against the interests of their investors. The requirement for fiduciaries to care about investors’ interests over their own helps clients trust advisors with their money. But does that mean that clients will only trust you if you take care of their financial interests exclusively?
Not necessarily. Clients are not only investors, but employees, consumers, and members of society. So, for example, if a retirement plan fiduciary votes in favor of a proxy proposal that will significantly reduce their investors’ employee benefits while helping them make a few extra bucks as investors, are these clients being properly served by their fiduciary?
Legal precedent says yes. “Under the ascendant—and flawed—interpretation of the fiduciary duty of loyalty, public pension trustees owe their allegiance to the fund itself, rather than to the fund’s participants and beneficiaries” even though the fiduciary’s duty of loyalty explicitly says that retirement plan trustees must invest “solely in the interest of the participants and beneficiaries,” writes law professor David Webber in his paper, “The Use and Abuse of Labor’s Capital.”
But should we as fiduciaries allow tobacco companies to dazzle our clients with portfolio profits while smoking-related medical bills soar? Should we permit oil companies to blind our clients with record earnings on the one hand while they worsen flooding in our clients’ homes on the other?
Or is there a better way—one that will allow us, as fiduciaries, to help our clients thrive as investors, as citizens, and as human beings? That is the debate that we should be having—as an industry and as a nation.
James Katz, Humankind
Courtesy Stanford Graduate School of Business
James Katz is the founder and CEO of Humankind Investments. Before founding Humankind, James worked in the ETF industry as a quantitative equity analyst and data scientist for Vanguard. He holds a Ph.D. in Business Administration from Stanford University’s Graduate School of Business and a BA in Psychology and PPE (Philosophy, Politics and Economics), as well as a BAS in Computer Science from the University of Pennsylvania. He is a CFA charterholder.