Impact investments: walking the legal tightrope

Whilst impact investments offer interesting investment opportunities for pension funds, trustees need to be aware of their fiduciary and other legal duties. The market size of impact investing was estimated to be US$715 billion in 2020, according to the Global Impact Investing Network and is expected to expand further. As the market grows and fund managers offer ever more opportunities in the impact investment space, pension fund trustees need to give careful thought to the legal framework for these potentially risky investments. 

But what exactly is ‘impact investing’? The definition is broad - these funds may touch on many areas, such as agricultural finance, social housing projects, clean energy, and infrastructure for developing communities. So “impact investing” means the allocation of capital to generate positive social or environmental outcomes. Although impact funds are designed to achieve these goals, this is not necessarily a zero-sum game with respect to financial returns.

From a legal perspective, pension fund trustees must exercise their investment powers for the “proper purpose” of the trust meaning that, in an investment context, they should act in the “best financial interests” of members and beneficiaries. Trustees must consider when and how to use their investment powers in particular circumstances; follow proper decision-making processes; take account of relevant factors; and not make irrational decisions. This can mean different things in different circumstances. 

It is likely to be difficult for trustees to show that it is for the benefit of the members as a whole to receive less financially. This can make impact investing challenging where impact funds clearly sacrifice financial returns in the pursuit of social or environmental goals. It will be difficult to justify how trustees are acting in the best financial interests of members in these circumstances. 

It is generally agreed that where trustees are choosing to invest in certain asset classes for ethical or religious reasons (i.e., “non-financial” factors), trustees need to be satisfied that there is good reason to believe members would support those views and the decision would not cause financial detriment to the pension scheme. Canvassing members’ opinions on ethical issues will often be practically challenging and may open trustees to litigation from opposing members. 

But trustees’ core fiduciary duties may align with impact funds’ investment objectives. On taking investment and legal advice, trustees may conclude that impact investments align with trustees’ fiduciary duties to act in the best interests of members. So, for example, impact investments could form part of a wider portfolio which provides different levels of risk, or an alternative investment strategy balanced against the rest of the portfolio. Investment in new technologies which improve food supplies or provide cleaner energy may offer risk or asset diversification within the scheme’s portfolio. 

For DC schemes, an impact investment strategy could feature in the DC default fund, but trustees must ensure they meet their fiduciary and other legal duties. Where self-select funds are offered to members, it may be open to trustees to include impact investments within that portfolio. How are these funds performing though and do they really do as they claim? Trustees will need to monitor the performance of the full range of self-select funds and ensure the portfolio remains appropriate to members’ needs based on the make-up of the population of members for that scheme. 

So, in short, trustees need to take appropriate investment and legal advice when making these investment decisions and ensure that such decisions are carefully documented – particularly when it comes to considering impact investments.