Social Investing and the Law of Trusts

In Part I, after presenting a brief primer on the economics of securities markets, we analyze the economic and policy issues presented by social investing. We conclude that the usual forms of social investing involve a combination of reduced diversification and higher administrative costs not offset by net consumption gains to the investment beneficiaries. Social investing may therefore be economically unsound even though there is no reason to expect a portfolio constructed in accordance with the usual principles of social investment to yield a below-average rate of return – provided that administrative costs are ignored.

Part II relates our policy analysis to the law of trust investing. We conclude that the duty of loyalty, the prudent-man rule, and cognate doctrines, which govern both pension funds and trust investment generally, forbid social investing in its current form. But if the pension-fund beneficiary is allowed to opt out of any fund that practices social investment and into one that pursues investor financial welfare single-mindedly, social investing may be a reasonable and, under the ratification doctrine, legally permissible investment strategy for pension funds and related types of trusts. Part III extends our analysis to the university endowment fund, where the rights of individual beneficiaries do not hamper fiduciary investment decisions, but where a variety of other legal and practical hazards confront trustees who permit non-economic considerations to affect portfolio construction.