- Universal owners, such as pension funds, own significant slices of the economy and are more vulnerable to economic crises.
- The societal impact of energy company prices will affect other parts of the portfolios of diversified investors, experts argue.
- Stewardship on systemic risks is in early stages, but there is growing investor interest in developing this further.
The Europe-wide energy crisis is hitting the UK especially hard, where a lack of government intervention means energy bills could leap by 80% this winter.
There are fears the hike will devastate the UK economy with millions plunged into poverty and small businesses forced to close. Although this is likely to be countenanced by the arrival of Liz Truss as the country’s prime minister – she has promised to effectively cap energy bills – the fact we are on the precipice of such a dramatic event is of great concern.
Jonn Elledge, writing in the New Statesman, warns: “Once a significant proportion of the British public can’t afford to eat out or socialise anymore, this is going to get much, much worse. Businesses will close. Jobs will be lost. And then, those negative effects will multiply.”
Elledge’s comments reflect the concept of systems thinking. A field which looks at how different parts of a system fit together and interrelate rather than breaking them down into separate silos. Importantly, in recognising how different parts are connected and interdependent, it leads to understanding on how actions in one part have consequences in another.
Put simply, it’s bad for an economy overall, if one part does well (energy companies) if it is to the detriment of others, such as consumer goods and services.
This also applies to investment portfolios, especially those of universal owners, who own a representative slice of the economy. The concept of universal ownership has been around since at least the 2000s and is built on the premise that being invested in a large part of the economy effectively means you are invested in the whole of it.
Using the energy price crisis as an example, BP reported its biggest quarterly profit for 14 years, delivering a 10% increase in its quarterly dividend. Curiously, investors remain tight-lipped over whether this is truly sustainable, certainly as households face rocketing energy bills. That said, Mark Carney, the figurehead for the influential Glasgow Financial Alliance for Net Zero, has said the windfall profits of energy companies should help fund the energy transition.
Sara Murphy, chief strategy officer at US-based non-profit The Shareholder Commons (TSC), a non-profit that seeks to reform the capital markets, explains it is a fallacy to incentivise the maximisation of profits at individual holdings level in a broadly diversified portfolio.
This means that universal owners have an interest in the long-term health of the economy, especially as they can’t diversify away from systemic risks like climate change, biodiversity loss or inequality.
TSC last year began filing shareholder proposals with systemic risk front and centre of them.
It files two types of shareholder resolutions. One is focused on disclosing the costs imposed on society or externalized by a company’s contribution to specific systemic risks. These risks include antimicrobial resistance, inequality, corporate governance failures, public health threats, and inadequate voting policies. The second type is calling for the company to convert to a public benefit corporation (PBC) structure. The PBC structure allows directors of a company to better serve the interests of diversified stakeholders such as workers and the environment.
Paradoxically, TSC means to change investor behaviour, more so than corporate. The shareholder ousting of former CEO Emmanuel Faber from Danone in 2021 is a case in point. His push to make the company more focused on sustainability riled many shareholders. TSC has had success making changes, notably with Yum! Brands, and this year its resolutions have garnered an average of 11% of external shareholder support, up from 2-3% last year.
Murphy cites an example from the book Moving Beyond Modern Portfolio Theory of investor reluctance. “There was a shocking quote….where the CEO of Citigroup said publicly at a conference ‘we should control for systemic risk, but then other people would benefit besides our clients’.
“It is recognising that companies are currently fettered by the system….corporate leadership wanting to really address systemic risks is hobbled by how far they can go because investors end up punishing them if they go too far in such a way that might undermine their enterprise value,” says Murphy.
A sentiment shift
Investment consultants tell Capital Monitor that investors are in the very early stages of thinking about systemic risk seriously.
Adam Gillett, head of sustainable investment at investment consultancy Willis Towers Watson, says they are linking their day-to-day life to their professional life much more. And from an investment perspective, the risk of climate change over the long term to portfolios is more apparent. Roger Urwin, global head of investment content at Willis Towers Watson, has long opined on the issue.
In March, Willis Towers Watson’s Thinking Ahead Institute released a survey of pension funds with assets totalling £55trn. It found a key theme for them this year would be climate risk, net zero and systemic risk.
Over the next decade, it predicts pension fund boards will seek to redefine their investment models aligned with systems thinking, through adopting concepts such as universal ownership or total portfolio approach to safeguard the climate and financial system and support the goals of sustainable growth.
Gillett says the thinking is built upon the belief that investors can only get returns from a system that works, and those returns are worth more in a world worth living in.
He adds that for a universal owner the majority of returns come from beta. Both Gillett and Murphy advocate for a stewardship approach to address systemic risks.
The concept of beta stewardship, outlined by TSC, starts from the premise that individual company performance is responsible for at most 25% of the performance of a diversified portfolio, the rest is explained by the performance of the market.
That means investors’ primary interest is in making sure individual company decisions don’t negatively harm the economy as a whole, which will lower portfolio returns for all investors.
While Modern Portfolio Theory (MPT) focuses on increasing alpha, so-called universal ownership theory (OUT) seeks to increase alpha and beta.
Universal ownership in practice
A number of papers have been written on how investors incorporate universal ownership in practice from the likes of the PRI and Ellen Quigley.
Dan Mikulskis, partner at UK-based investment consultancy Lane Clark Peacock (LCP), says: “Historically companies could misbehave, make money and everyone basically shrugged.” That is changing with the universal owner mindset, he adds, but asset owners are just at the start of trying to figure out what that means and how to approach it.
“Trying to take a stance on an issue-by-issue basis is really tricky and probably doesn’t achieve much.”
He says it is more effective for an asset owner to define policy to an overall approach to a systemic issue, then individual voting decisions can flow from that. “To make that process stand a good chance of working you don’t want to be taking a quick spot judgement on the company of the moment and trying to engage the company based on that. It probably won’t work."
Mikulskis adds that asset owner initiatives with “well-designed” frameworks such as Climate Action100+ play a role in building that long-term perspective.
That may be so, but, as Capital Monitor argued in an opinion piece in August, such initiatives still have a long way to go themselves before achieving any credibility.
Capital Monitor is hosting the second part of its Webinar series, Making Sense of Net Zero, alongside New Statesman and Tech Monitor on September 21. Find out more information on NSMG.live.