This article was first published in 2022 as part of our ESG Week
Last year I wrote a piece about "custodians" after an abysmal series of events exposed some cryptocurrency companies for being very bad at looking after investors’ money.
During our ESG Week, we were focusing on the opposite end of spectrum – seeking out exemplary companies, industries and fund managers – and emphasising some of the loftier principles of the sustainable investing revolution.
But as I found with custody, words are in danger of becoming a debased currency in the rush to make net-zero – especially with terms like "stewardship", "governance" and "custodians" being used interchangeably by the media and asset managers alike.
We could file these words under the meaning "doing good things for the world". But in a world driven by data and precision, we should expect more clarity from companies selling us the ESG dream. I’m going to try to disentangle some of the terms and at least pin down what they are attempting to convey.
Professional investors are judged by results, of course, and at this stage we can assess whether they’ve been the good stewards, custodians or governors of our capital, or neither!
Fire And Forget
Starting at first principles, let’s revisit custodianship and why it differs from stewardship.
Custody services are a familiar one in asset management and a narrow one that involves safeguarding and safekeeping money.
On a wider level though, the question is: when I, as an investor, give my money to institution, who makes sure it’s "safe", and can I get it back? From the dotcom boom to crypto coins, each wave of financial hype is followed by scandals, leaving investors wondering what happened to their money.
The job of regulators is to repeat the mantra that your capital is at risk. Financial institutions exist on a wide spectrum of trustworthiness – but not all companies are equally good custodians of your cash.
I would argue here that custody is relatively passive concept: in buying a basic savings product from NS&I, which is backed by the UK government, I can sleep at night knowing it will still be there in the morning. Beyond security, however, I am not asking any more from this institution. This is custody in action.
If I buy their green bonds, however, NS&I is now assuming a stewardship role, which is more active and has bigger promises – "watch your savings make the world cleaner, greener and more sustainable".
This change of gear increases the responsibility of the investee to make good on these promises ("cleaner and greener” are suitably vague) but also on the investor to make sure their money has been used for the stated purposes. In some cases, people are happy to just let the stewards get on with it, as I explored in my article on charity and investing. "Transact and forget" is a common process and one that the financial services industry has used to its advantage in badging any fund that moves as "sustainable".
The Expert Take
Let’s look how the experts understand stewardship. The UK has its own Stewardship Code, published in 2020. It defines it as: "The responsible allocation, management and oversight of capital to create long-term value for clients and beneficiaries leading to sustainable benefits for the economy, the environment and society.
Turning to the United Nations, its Principles for Responsible Investment defines it thus, first in terms of "overall long-term value" and then more specifically:
"Stewardship is investors using their influence over current or potential investees/issuers, policy makers, service providers and other stakeholders – often collaboratively – to maximise overall long-term value. This includes the value of the common economic, social and environmental assets on which returns and clients’ and beneficiaries’ interests depend."
A few things to unpack here: the key word is probably "influence", which suggests that asset managers are actively trying to change behaviour of a company, government or "other stakeholders". That's a wide remit. The last sentence mentions "returns", which is a concrete goal – after all, ESG is there to make money sustainably and there’s no point in running a portfolio that improves the world but loses clients money. Here, the UN suggests there’s an interdependence between business interests and social or environmental goals.
On the investment industry’s point of view, the CFA Institute gets more specific and introduces another allied term, that of "engagement". (My colleague Sunniva Kolostyak has looked at how engagement has become the mantra of fund managers.)
The CFA says that stewardship is "generally understood" to mean "engagement by institutional investors with public companies to generate long-term value for beneficiaries, although specific definitions and principles differ across markets".
This is a key point: there’s no globally-understood one-size-fits-all definition of stewardship; and we need to be sensitive to local differences about best practice.
And this feels more realistic than the NS&I’s "cleaner/greener" slogan:
"Good stewardship contributes toward the building of sustainable economies by enabling more efficient capital allocation, fostering best practices in business management and corporate governance, and encouraging better risk management."
The industry is moving toward a goal, which implies there is work to be done. But the CFA is clear the investment world has some concrete "wins" in better stewardship: better use of money; better risk management; and, in world where many governments are not using money well or managing risk well, that's something to aspire to!
More Than Money
Finally, I like this from Stewart Investors (which runs the Gold-rated Indian Subcontinent Sustainability fund among others). What are good stewards, it asks?
"They are custodians who understand and carry out their responsibilities with integrity and respect for the people who rely on them and on whom they rely, and for the society and environment around them." Again, you can see custody is embedded in the concept of stewardship, and implies a care for client capital.
"Good stewardship is about looking after our clients’ savings as much as we’d look after our own – with good judgement and extreme care and consideration. It’s also about understanding our rights and responsibilities in respect of companies we have a share in."
Ultimately, small investors can’t by themselves change company behaviour. So we are asking money managers to do the heavy lifting in enacting change. That's as much a question of integrity as it is investment.
This article contains the author's views on ESG and custodianship; they are his alone
This comment piece reflects the opinions of the author and are not necessarily those of Morningstar
