Sustainable investing. Mission alignment. Impact investing. “ESG.” These terms all refer to the consideration of social and environmental factors in one’s investment decisions—a concept that is gaining serious traction in the investment universe. More than 2,350 institutional investors representing over $86 trillion (as of 6/30/2019) have signed the Principles for Responsible Investment (PRI), to demonstrate their commitment to sustainable investing. And recent IRS guidance has cleared the way for ERISA fiduciaries to incorporate mission-related investments more broadly in their portfolio strategies. However, for trustees that are considering a sustainable investment path, the decision is not always so straightforward. Put simply, trustees serve as fiduciaries with investment authority over assets that are intended to benefit another person or persons; trustees should use every device at their disposal in an effort to maximize the investment returns of the trust they oversee. To be sure, sustainable or mission-based investing is not inherently at odds with a trustee’s fiduciary duties. In some cases, investment managers consider environmental and social factors in an effort to reduce risk and improve returns, and such an approach can be in alignment with a fiduciary’s priorities. In other cases, sustainable investing may be considered as a way to reflect a grantor’s or beneficiary’s values. These situations are more challenging for a fiduciary. Do the standards of care and loyalty permit a trustee to consider factors other than financial returns when making investment decisions? To what extent does the specific language in a trust impact the trustee’s decision making on a sustainable investment? The answers to these questions are not simple—federal and state laws are continually evolving on these issues, and every trustee faces a unique set of circumstances when making decisions for a trust. BACKGROUND Originally articulated by the Massachusetts Supreme Judicial Court in 1830, the “prudent man rule” was an early guiding star for trustees making investment decisions for trust assets. That rule mandated that a trustee exercise “the same judgment and care as a prudent man would exercise in the management of his own affairs, with an emphasis on preserving the trust property.”1 The problem with this standard was that certain categories of investments were considered inherently speculative and thus out of bounds for trusts. The prudent man rule favored safe investments such as bonds, vs. riskier investments such as equities. Moreover, in interpreting the prudent man rule, courts assessed the prudence of each investment in isolation, without considering how various investments interacted across a diversified portfolio. Eventually, the more flexible “prudent investor rule” rose to prominence.2 The prudent investor rule requires a trustee to preserve a trust’s property, and to make it productive, while acting with reasonable care, skill, caution, and undivided loyalty to the beneficiaries.3 Over the last two decades, the prudent investor rule has replaced the prudent man rule in a majority of U.S. states.4 The Uniform Prudent Investor Act (UPIA) is informed and guided by modern portfolio theory; it directs trustees to invest on the basis of risk and return objectives that are appropriate for the trust, and instructs courts to consider the suitability of the trust portfolio as a whole, rather than focusing only on each investment in isolation. The UPIA also includes a non-exclusive list of factors that a trustee may consider when making investment decisions.5 This list generally increases a trustee’s responsibility to weigh the particular needs of the trust and beneficiaries, as opposed to a “pure” focus on absolute results. In addition to allowing trustees to consider the liquidity and income needs of beneficiaries, the UPIA specifically calls for consideration of the “special relationship or special value” of an asset to the trust or to one or more beneficiaries. State trust laws are also important to consider; while many states have adopted the UPIA in principle, some have added their own interpretations. A notable example is Delaware; the 2018 Delaware Trust Act added language that allowed trustees to consider “the beneficiaries’ personal values, including the beneficiaries’ desire to engage in sustainable investing strategies that align with the beneficiaries’ social, environmental, governance or other values or beliefs.” ESG AND FIDUCIARY RESPONSIBILITY Many believe that sustainable investing does not violate fiduciary duty, and in fact, can be symbiotic with it. Society—and with it, the economy and capital markets—are affected today by concerns that may not have been on the radar 30 years ago, and environmental and social issues have the potential to affect the viability and long-term growth trajectory of investments. Reading the UPIA with sustainability in mind, a trustee could come to the conclusion that environmental, social and governance (ESG) research should be taken into account when it is reasonably believed that the ESG factors in question will have an impact on financial return or risk. Many investors take the view that long-term risk-adjusted returns can be improved by properly considering ESG factors in the investment process. There is mounting evidence to support this view. Academic research on sustainable investing reveals that high ESG ratings are correlated with a lower cost of capital, market-based outperformance, and accounting-based outperformance. We believe this research aligns with common sense; environmental misconduct can lead to meaningful costs and penalties, and unethical conduct can damage a company’s reputation and brand. On the other hand, there are many examples today of companies who are building successful businesses by solving environmental challenges for customers, or earning customer loyalty through commitment to sustainable practices. Against this backdrop, a fiduciary is within the bounds of duty if they consider ESG factors, alongside their investment advisor and counsel, when constructing a trust portfolio. The case-law support for sustainable investing in trusts appears strongest when there is a reliable indication that the beneficiaries want these factors to be taken into account, and when a trust settlor includes language authorizing or even requiring that thought be given to sustainable investments. While the UPIA does not mention ESG investing specifically, the clause requiring trustees to evaluate the “special relationship or special value” of an investment offers flexibility for considering the ESG preferences of grantors or beneficiaries if those preferences are documented. And, as noted above, certain states may have laws that offer more clear-cut permission for trustees to consider the ESG preferences of beneficiaries. Courts acknowledge the variance in how different investors, each acting prudently, may choose to invest. For this reason, the trustee is not judged solely on the success or failure of the investment, but on the prudence of the trustee’s conduct. Long-term risks such as climate change and social equality have become increasingly important factors when making investment decisions. The consideration of non-financial data about ESG practices can offer deeper insight into a company’s long-term trajectory, beyond the information provided by traditional fundamental analysis alone. ESG investing seeks to deliver attractive returns while evaluating, at every stage of the investment process, the long-term impact of a company’s business practices on society, the environment and the performance of the business itself. Additionally, if there are otherwise equally attractive investments that are differentiated by ESG considerations, these ESG issues can be taken into account to the extent that they will not harm financial returns. HOW TO PROCEED Under a duty of care, we believe that fiduciaries generally have sufficient discretion to consider and choose sustainable investments, given the growing body of evidence suggesting that companies with sound ESG practices can exhibit reduced investment risk and attractive returns over the long term. A trustee may have even greater security in making sustainable investment decisions when the trust’s beneficiaries support those decisions, or if the terms of the trust document direct a trustee to consider sustainable or ESG investment factors. Every client’s situation is different, and there is no universal path for creating or overseeing trusts. That being said, we believe that there are a few general concepts that grantors and trustees should keep in mind: When creating trusts: If there is any thought about considering sustainable investment, it is wise to include clear instruction to that effect in the trust language. Grantors may wish to consider the preferences of their beneficiaries when drafting the trust language—grantors may seek to accommodate beneficiary preferences, or in some cases may wish to supersede them. When overseeing trusts without clear instruction: Trustees should seek to ensure unanimity among the trustees and the beneficiaries before adopting any new sustainable investment policies. When possible, trustees should seek modification to trust language so that any meaningful change in investment policy can be codified. When beneficiaries are divided: In a variety of scenarios, the beneficiaries of a trust may have strongly divergent views on sustainable investments. In these situations, it may be desirable to pursue strategies that create separate pools that satisfy the parties. When law and practicality allow, it may make sense to fully or partially decant the older trust, and distribute assets to newer trusts with divergent language to satisfy the differing preferences of the beneficiaries. As with most challenges facing trustees, there are no universal answers when it comes to incorporating ESG investing principles into a trust’s investment portfolio. Sustainable investing continues to gain momentum with mainstream investors, and trustees will be well served by staying abreast of evolving legislation and its interpretation—and, as always, by keeping the needs of the beneficiaries they serve at the forefront of their decisions. Harvard College v. Amoy, 26 Mass. (9 Pick) 446 (1830). Restatement (Third) of Trusts §90 (1992). Id. As of June 2017, states that have adopted the Prudent Investor Act in whole or in part include: Alabama, Alaska, Arizona, Arkansas, California, Colorado, Connecticut, District of Columbia, Hawaii, Idaho, Illinois, Indiana, Iowa, Kansas, Maryland, Maine, Massachusetts, Michigan, Minnesota, Mississippi, Missouri, Montana, Nebraska, Nevada, New Hampshire, New Jersey, New Mexico, North Carolina, North Dakota, Ohio, Oklahoma, Oregon, Rhode Island, South Carolina, South Dakota, Tennessee, Texas, U.S. Virgin Islands, Utah, Vermont, Virginia, Washington, West Virginia, Wisconsin, and Wyoming. The Uniform Prudent Investor Act provides a nonexclusive checklist of issues that a trustee should consider when investing trust assets including: General economic conditions; the possible effect of inflation or deflation; the expected tax consequences of investment decisions or strategies; the role that each investment or course of action plays within the overall trust portfolio, which may include financial assets, interests in closely held enterprises, tangible and intangible personal property, and real property; the expected total return from income and the appreciation of capital; other resources of the beneficiaries; needs for liquidity, regularity of income, and preservation or appreciation of capital; and an asset’s special relationship or special value, if any, to the purposes of the trust or to one or more of the beneficiaries. Prudent Investor Act §2(c) (Unif. Law Comm’n 1994). The views expressed are those of Brown Advisory as of the date referenced and are subject to change at any time based on market or other conditions. These views are not intended to be and should not be relied upon as investment advice and are not intended to be a forecast of future events or a guarantee of future results. Past performance is not a guarantee of future performance and you may not get back the amount invested. Any business or tax discussion contained in this communication is not intended as a thorough, in-depth analysis of specific issues. The information provided in this material is not intended to be and should not be considered to be a recommendation or suggestion to engage in or refrain from a particular course of action or to make or hold a particular investment or pursue a particular investment strategy, including whether or not to buy, sell, or hold any of the securities mentioned. It should not be assumed that investments in such securities have been or will be profitable. To the extent specific securities are mentioned, they have been selected by the author on an objective basis to illustrate views expressed in the commentary and do not represent all of the securities purchased, sold or recommended for advisory clients. The information contained herein has been prepared from sources believed reliable but is not guaranteed by us as to its timeliness or accuracy, and is not a complete summary or statement of all available data. This piece is intended solely for our clients and prospective clients, is for informational purposes only, and is not individually tailored for or directed to any particular client or prospective client.