The Bottom Line: Challenges arising for fund companies that trend into the public policy arena can best be remedied through transparency, disclosure and reporting practices.
Introduction
Identifying sustainable fund managers and their parent companies by their political as well as environmental, social and governance (ESG)-related positions has recently become more common. A potential undesired side-effect of this is that the public image and perception of a fund company’s position with respect to such issues may not be consistent with a fund manager’s investment approach or intent. Moreover, stating such conclusions may have little to do with a fund manager’s record in meeting their investment and related fiduciary responsibilities. As a result, fund management companies may be singled out and called upon to be arbiters of what sustainability issues are important to a constituency beyond their shareholders.
In such situations, fund management companies may take on roles beyond their traditional fiduciary duties. In doing so, it raises questions about whether they are overstepping these duties. This may also involve defining policies for a broader public-base seeking answers to sometimes “thorny” sustainability questions. A possible outcome of this is that fund companies may be “forced” to assume a de facto public policy role. In some cases, they may take on a broader range of policy responsibilities having little or nothing to do with their positions as investment managers. Complicating matters even more is that the politicization of fund manager’s sustainability products, investment processes, and overall corporate identities may not be uniformly implemented within or among companies.
In the following sections, we identify some of the potential consequences of fund companies trending into the public policy arena.
Heightened Fund Company Exposure
As the sustainable investment market has grown, fund management companies have increasingly become aware of the potential effects on their images with respect to politically sensitive issues. This has often been in response to competitive concerns involving new entrants to the fund industry that offer specialized and innovative sustainability products. These “pioneers” have traditionally not been considered mainstream industry players, but rather niche entities. They typically did not “downplay” their sustainable investment processes, but as smaller and often less visible players in the fund marketplace, their socio-political positions were generally not as controversial from the standpoint of the broader public. Some of these sustainable mutual fund forerunners include: Calvert, Green Century, Nuveen (TIAA), Eventide, and Parnassus.
Newer entrants to the sustainable fund market have sometimes taken on a “catch-up” role. In these cases, fund managers have been largely self-defined by an alignment and on-going sensitivity to “mainstream” public sustainability concerns. More recently, some of these companies seem intent on reinforcing their investment “reputations” by incorporating a “fluid” range of sustainability considerations in their investment processes. Others have simply rebranded their existing funds to reflect sustainable considerations.
Unfortunately, fund companies employing such methods may limit their flexibility when defining and controlling their images related to sustainable issues. This is because as sustainability concerns evolve, fund companies adopting such strategies are forced to continually adjust their investment considerations and weightings. In doing so, they may take on unintended “reputational” risks associated with highly charged or even unpopular “hot button” stances.
Reputational Risk Concerns Stand Out
The recent case involving BlackRock is an example of how a fund manager’s sustainability stance can “backfire.” BlackRock’s CEO Larry Fink recanted on using the “ESG” moniker in response to the potential risk implications faced when building their sustainable investment positions. After taking a lead in the industry’s support of ESG investing, he publically stepped back. The reason being that he believed that “ESG” terminology had become politically “weaponized” and “misused by both the far left and far right.” More recently in November 2024, BlackRock changed the name of some of its funds by eliminating “Sustainable” from their titles, and lessening their ESG investment policy restrictions. And even more recently, BlackRock resigned from the Net Zero Asset Managers (“NZAM”) initiative (although its international subsidiary retained its membership). One could argue that these actions not only hurt BlackRock’s reputation among the investing public, but also, the environmental cause overall.
BlackRock was not alone in their retrenching. Other more recent responses by domestic fund management companies including: The Vanguard Group, State Street Global, and J.P. Morgan are just some of the firms that have “pulled-back” after having publicly supported and joining the UN’s NZAM Initiative. These fund companies reportedly stated that they could better represent and conduct their own sustainability management research using in-house specialized capabilities. Although these cases were not necessarily in response to targeted criticism, they nonetheless reflect actions to limit fund companies reputational exposure, legal risks and ultimately, concerns over their competitive viability.
Misleading Claims Targeting Sustainable Investing
A review of critics’ comments on sustainable investing finds that they often overlook or just don’t understand the complexity of such fund portfolio management processes. As a result, they sometimes omit critical factors that are instrumental in determining a fund’s investment strengths and weaknesses, when meeting shareholder’s sustainable investment objectives. At the same time, they sometimes overlook insights which more precisely define a fund’s sustainable investment approach, factors weightings, and financial risk considerations beyond its political stance. These include the:- Effects of Sustainability Factors on Financial Risks and Returns: It is important to recognize that the portfolio management process and those charged with its conduct, have a fiduciary duty to act on behalf of all of their investors’ financial interest. This does not mean that financial returns and risk objectives exclude or down-play financially material sustainability considerations. As a practical matter, the opposite may be true.
Sustainability factors and their performance implications are increasingly being recognized as critical contributors to investment risk-returns. For example, a company whose production process is heavily reliant upon high carbon-based fossil fuels is exposed to costs and risks that their non-carbon based competitors are not. This may affect their future revenues, cash flows and valuations. Even non-pecuniary sustainability factors may have value implications from a fiduciary standpoint. Consider for example, the case of real estate with scenic ocean views. Such waterfront sites typically are valued higher than those inland because of their scenic vistas. They are also more prone to the risk of flooding as exhibited by their higher insurance costs. Such sustainable-related issues are present regardless of a fund’s mandate.
- Complexity and Specialization of Sustainable Investment Processes: A fund’s sustainable investment approach, policies, and restrictions introduce added layers of complexity to its portfolio management and research processes. These analytics are needed to evaluate and select sustainable investments, and may be distinctive from the corporate business concerns of non-sustainable investments. To evaluate such factors, a fund’s portfolio manager may be called upon to measure and weigh a company’s sustainability culture, business practices, community outreach programs and involvement record. This sometimes requires qualitative and intuitive inputs as well as, quantitative analytical judgements which are unique to individual sustainability cases. At the same time, such analytical criteria may not always be considered in traditional financial investment assessments.
- Role of Sustainable Engagement and Collaborations: Criticism of sustainable investing often centers on fund manager’s engagement with companies and issuers of securities held or being considered as portfolio positions, and their proxy voting positions. It has been suggested that such activities may be “collusive”. That is, it is a means to force companies into taking atypical actions, and by extension adopting stances that “distort” the market. While a fund’s position as a large shareholder of a company’s stock may carry weight toward defining its business practices and positions, it also reflects shareholder objectives and by extension, financial market concerns. However, questions sometimes arise when non-shareholder interest groups become part of the debate. Such practices must be examined with respect to the fund manager’s stated engagement and proxy voting guidelines, practices and record. Engagement processes are typically multi-sided and subject to a fund’s financial investment requirements and investors’ objectives. This individualization is normalized by the fund company’s engagement practices and the stringency of their application.
- Variability of Sustainable Investment Disclosure and Transparency: The level of financial transparency and disclosure related to a fund manager’s investment approach, restrictions and policies is especially important when judging a sustainable management process. It also raises fundament questions regarding the sustainable fund’s results and intensions, political or otherwise, are compared and judged. Disclosure practices for sustainable funds are as varied as their investment as well as engagement processes. To make judgements about a fund’s political positions without a complete and “normalized” record of this information, is believed to be nothing more than guesswork.
Gaps in Regulatory Coverage and Guidance
Currently, there are few rules guiding the “imaging” processes related to sustainable investing. Little, if any attention has been placed on regulating practices related to defining a sustainable fund manager’s political identity and image. If history is any guide, when such rules are made, they can be expected to initially focus on establishing disclosure and labelling standards. But, even if guidelines are introduced, they are likely to be broadly defined and allow for manager leeway.
Legal actions calling for restricting the use of sustainability factors in investment processes of publicly sponsored pension plan choices, have become restrictive in a number of jurisdictions (see Texas, Oklahoma, and West Virginia). The argument typically used states that the inclusion of sustainability criteria violates fiduciary guidelines. One state, New Hampshire, has gone so far as to label it as “criminal”. In these cases, named fund companies were sometimes excluded from consideration as asset managers for state engagements or removed from their current positions.
Even though with time, one can expect there to be “competitive comparable” standards to build off of, the risk trade-off is likely to be judged by a question of “how far is too far” before a fund company’s investor-base becomes alienated. As a result, the choice between corporate financial responsibilities and public demands regarding sustainability issues is expected to remain an “individualized” fund manager decision.
Various Factors Dictate Fund Manager’s Public Responses(s)
Barring legal rulings and codified regulations, fund companies will be on their own when defining and implementing their sustainable beliefs and values – not unlike their shareholder currently face. This situation will challenge fund managers seeking a neat and clean definition of where they stand on the diverse and evolving range of sustainability issues.
Once established throughout the industry, however, manager identity related to these issues is expected to result in a more stratified sustainable fund marketplace. This will offer investors a clearer picture of what they are getting and giving through their sustainable fund purchases. At the same time, fund companies will be in a better position to synchronize their corporate culture(s) through the fund products and investment processes they offer. This is considered to be a value-added beyond simply selling products.
The role of fund management companies as public “arbiters” and possibly proponents of sustainability concerns is expected to increasingly be a function of the nature of the issue within the context of a firm’s strategic standing. In some cases, management companies may have no choice but to diversify their market presence by introducing fund products that embrace and advance certain sustainable causes. The opposite may also occur.
Other than competitive concerns, a central factor contributing to a fund manager’s willingness to take a socio-political position is its legal structure. That is, whether it is a private or publicly held entity. Also important is whether the product-line of a fund company’s parent organization includes services beyond mutual fund and ETF management. These may be those offered by their parent company’s affiliated businesses such as banking and insurance. Each may have distinctive markets with different sustainability sensibilities.
Conclusion: “Political” Challenges for Sustainable Investing Will Continue
Efforts by fund management companies to fashion their corporate images regarding sustainability concerns, are considered to be just starting. Continued integrations of corporate “soul searching” over new and evolving sustainability concerns and their implications will continue as a serious topic of debate both within and among fund companies. These assessments will need to be continuously fine-tuned to reflect how fund managers wish to be perceived by not only their direct stakeholders, but also by legislators and politicians, the market, their employees as well as the the general public. These entities can be expected to frequently and vocally express opinions on such matters. Politicians are expected to be especially vocal on sustainability matters, largely because this comes with their “jobs”.
These processes and their pressures can be expected to go beyond the fiduciary and sustainability related issues facing fund managers today. They are likely to become more “personalized” for investment companies and their staffs. The public’s perception and response to a fund company’s actions or lack of them on sustainability considerations is already present. In time, it can be expected to grow to cover a wider and more diverse array of topics. These will likely cover issues related to a fund parent company’s policies, business practices, and their employee’s behavior.
Overall, it will become important for fund management companies to “truly” represent their investors’ beliefs and values. This “representation” is expected to further evolve to cover not only their investment fund products and wealth management services, but all aspects of their business practices. As a result, fund managers will possibly even need to proactively and possibly publicly limit their activities in selected markets. It may also require that fund management companies and their employees exhibit a commitment to their sustainability image and socio-economic causes. This will involve highly individualized questions at both the corporate and employee levels.
The most direct remedy to these challenges, beyond the adoption of various industry-wide standards, is likely to center around the fund company’s transparency, disclosures, and reporting practices. At minimum, we believe that these should address definitions for various sustainable investing terms, criteria and related considerations, clarifying the fund company’s sustainable investing approach and methodologies, including the relevant sustainability factors employed when managing their portfolios, and the impacts of their strategies on financial and non-financial outcomes. By consistently providing such details, shareholders know what they are investing in and by extension, what fund products represent to the general public.
Authors: Steve Schoepke and Henry Shilling
