Green machines

David Prosser discusses the ESG merits of investment companies.

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David Prosser discusses the ESG merits of investment companies.

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The idea that you can do well by doing good continues to be fashionable with investors, who have been making significant commitments to assets with an environmental, social or governance (ESG) flavour. So it is not surprising that the Schroder BSC Social Impact Trust raised £75m from investors just before Christmas despite a difficult market for investment company new issues.

The launch is a joint venture between Schroders and Big Society Capital, an investment bank that specialises in social impact investment, and will put its money into a portfolio of assets including social housing, loans to charities and projects for societal good. Investors are not expected to be altruists; the fund is targeting an annual return of inflation plus 2 percentage points. It will also offer excellent diversification properties, given that the assets being targeted have little or no correlation to mainstream asset classes such as equities and bonds.

One of the challenging debates in ESG investment is whether portfolio managers such as pension funds and wealth managers are acting in investors’ best interests when they make asset allocation decisions on the basis of factors other than what will drive investment returns. Is a manager who focuses on the ESG aspect of the portfolio, rather than solely on performance, serving investors well?

For a specialist fund such as Schroder BSC Social Impact Trust, that is less of a concern. Investors understand what they are signing up for when they put money into the fund; they have actively chosen a vehicle that seeks to have a positive impact on society as well as generating commercial rates of return.

Still, this is an investment company. Its directors have the same responsibilities to their shareholders as those as every other stock market-listed company. And the concept of fiduciary duty is sacrosanct. The board of every investment company must act independently of the portfolio manager, running the company solely in the best interests of shareholders.

In fact, there is a broader point here. Not only is there no conflict between the fiduciary duties of the directors of this fund – who are promising from the outset to deliver performance in the form of both financial returns and social impact – but also, the structure of an investment company is a strong fit with the principles of ESG.

Investment companies, after all, are run for their shareholders – and by them, since board directors are elected. They are not a million miles away from mutual organisations such as building societies, which serve their members rather than parties who may have conflicting interests.

This is in stark contrast to open-ended funds, which are essentially products managed by a fund management firm. As with any product, the provider’s motivation is to maximise its own profit; hopefully, investors do well as the provider pursues that goal, but there may be times when their interests do not coincide.

For this reason, the investment company structure is a type of collective fund that is uniquely well-suited to ESG investment. The very structure of the fund sits comfortably with the “governance” element of ESG.

It is therefore to be hoped that we will see more funds launched in the same vein as Schroder BSC Social Impact Trust. There is no reason that open-ended fund managers cannot also pursue similar ventures, but the investment company structure feels particularly appropriate here.

 

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