If at any point of your life, you’ve put money toward your pension or invested money, chances are some of your money is being handled by an asset manager. This asset manager has a “fiduciary duty” to you; they must act in your best interests and earn you the greatest return for your own risk tolerance. Yet this broad term, the origins of which come from English property law in the Middle Ages, has been subjected to scrutiny in recent years, as questions about what factors into “fiduciary duty” come to the fore.

The logic underpinning fiduciary duty may make perfect sense; ensuring through law that the best interests of an individual are being met by those managing their funds. If an individual, perhaps for ethical reasons, desires their money to be managed in a way that doesn’t optimize their returns (and research suggests many do), the manager must follow their wishes, albeit while being legally obliged to fully explain the financial implications.

So why has this seemingly innocuous legal term become so controversial? Fiduciary duty hit the headlines in 2023 when the state of Florida signed into law a ban that prevented investment managers from considering ESG (Environmental, Social, and Governance) factors in their decision-making. Now, by law, only “financial factors” can be taken into account when attempting to maximize the return on an investment.

Again, at first glance, this may seem sagacious; it should mean protection—in law—against the well-studied principal-agent problem, in which the interests of the owners of the money, the principals, are not aligned with the interests of those looking after it, the agents. An example of this problem arises in the payment structure of asset managers (agents), which often includes a bonus for outperformance but no loss for underperformance. The manager is therefore incentivized to chase the upside by taking more risk than the investor (principal) is able to because the manager faces no consequence from loss. Misalignment in this area is typically rectified through regulation and compensation alignment, so why not use regulation to ensure that only financial matters are taken into account when managing a person’s money?

The problem is that the two tenets of this legislation are at odds with each other. In many, if not a majority of cases, ESG factors are necessarily financially material, and the two pillars of the Floridian law are therefore contradictory. If a company’s factories are situated near the sea, climate-change related sea level rise is demonstrably a risk to the money you have invested. If a company is using child labor in a supply chain, there’s significant reputational concern that could impact future stock prices. If a company is heavily emitting greenhouse gases with no reduction strategy, future regulation that could necessitate expenditure on aligning operations, or that could introduce fines on the company, clearly represents financial risk. Such risks are well-studied in financial and economic literature, and some evidence even points to an outperformance by asset managers who systematically integrate ESG factors into their analysis and decision-making.

Taking a wider perspective, failure to incorporate environmental and social issues into investment decision-making creates negative societal consequences. It pushes capital toward the most profit-maximizing companies with no regard for their production of negative externalities, and incentivizes companies to put profits before ethical considerations, such as the well-being of their workforces and the quality of their production and services. Additionally, mandating a shift in capital away from typical ESG investments, such as companies operating in renewable energy and other solutions industries, hinders global transition efforts. The ultimate cost of this is borne by the very individuals fiduciary duty law claims to protect. As one major asset manager puts it, there’s no point creating value for a person’s pension if they do not have a “livable world” in which to claim it.

The controversy surrounding fiduciary duty and its intersection with ESG factors underscores the need for a more nuanced approach to investment management. Recognizing that ethical considerations can also be financially material is essential to aligning the interests of investors and asset managers while advancing a more just and sustainable financial future for all. Balancing financial returns with responsible investing can lead to more inclusive, equitable, and environmentally conscious financial practices, ultimately benefiting both individual investors and society as a whole.

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