Why universal owners need modest objectives
Tom Gosling, executive fellow at London Business School argues that by aiming for less, asset owners can achieve more as universal owners
A widely used rationale for investor action on environmental or social issues is the concept of “universal ownership”, sometimes referred to as “systemic stewardship” or “system level investing”.[1] The idea is that broadly diversified investors own a slice of the whole economy, that is, they are “universal owners”. Therefore, it is in their interests to address any issue that adversely effects the economy as a whole. In this view, if [insert your favourite ESG issue] can be claimed to cause long-term economic damage, thereby reducing the value of the market portfolio, then there is a financial argument for investor action.
The archetypal example is climate change. Oil companies may profit by spewing off unpriced carbon pollution. But in fuelling climate change, they create large potential damage to, say, the real-estate and food companies in an investor’s portfolio, which far outweighs the gains for oil producers. The solution: universal owners should act to force oil companies to cut production so as to mitigate the carbon externality. Oil company shares may fall, but the far greater costs elsewhere in the investor’s portfolio will be reduced.
Reality check
The theory is useful for activists as it provides a horse to which any favoured ESG wagon may be hitched, creating a financial motivation that makes fiduciary duty an ally rather than an impediment to ESG action. Proponents have claimed that the theory can be applied to issues as diverse as climate change, biodiversity loss, inequality, population health, microbial resistance, and access to vaccines.
But the theory quickly runs into problems when in contact with reality, as I show in a recent review of the evidence on universal ownership.[2] But as I also outline, there is a roadmap for investors who do want to make a difference.
A first order issue is that it is often difficult to prove that taming the externality will actually be good for market valuations over the time horizons of interest, even if it may be good for society and the economy. We should not be surprised to learn that financial markets do not always reward what is truly valuable – indeed this is the very essence of an externality. But setting that issue to one side, the practical problems boil down to the efficacy of investor action and the gap between company and system level effects.
Starting with the efficacy of investor action, the tools investors have at their disposal are quite weak. Preferential capital allocation can in principle lower the cost of capital of clean firms and raise it for bad ones. But the impacts are modest and there is little evidence of them leading to significant company action in response. Moreover, typical estimates of realistic cost of capital impacts, which are of the order of 100 basis points, have an impact far less than, for example, necessary levels of carbon taxation to hit net zero goals. Indeed, there is a concern that constraining finance to dirty firms may cause them to double down on brown rather than green activities.
There is more evidence that engagement “works”, but even here the results should not be overstated. While some studies find success rates as high as 50% for collaborative engagements, the definition of success is often underwhelming: improved disclosure or a commitment to some as yet vaguely defined future action. There is no evidence that investor engagement can persuade companies to undertake costly actions that undermine long-term financial value creation.
A theory of change
Moving onto the gap between company and system level effects, investors need a coherent theory of change. Will the impact they have lead to system-wide change or will it simply be undone by other actors in the system? If an investor engages with a bank to reduce fossil fuel lending, will the fossil fuel firm simply get the funds from another bank? If the fossil fuel firm’s production is cut will a state owned or other private actor take up the slack? And what if it does work? The climate transition will create profound distributional effects, with winners and losers. Investors rightly talk about a just transition but are ill-equipped to bring it about. Even if successful, investor action would only create the change, not the necessary societal response to it.
The chain of causality from investor action to company action through to effective system change is a rusty one with many fragile links. The investor’s tools to bring about change are quite weak. Wise investors acknowledge this, not as an admission of failure, but out of resolve to focus their actions where they can be most impactful, while meeting their fiduciary duties to clients and beneficiaries. This often means influencing the environment in which sustainable outcomes can emerge rather than trying to bring them about directly.
This can include engaging with companies, but in a way that recognises the limitations: engagement cannot overcome fundamental economics and needs to go with the grain of long-term value creation for the company. Asks made of companies must be within a realistic zone of director discretion. It can include advocating consistently and actively for coherent government policy – an essential requirement for a successful energy transition – or resisting the worst excesses of lobbying by companies you own that have incumbent vested interests. It can mean providing resources and expertise to work with stakeholders to help create investible blended finance projects at a scale to enable the transition. And it can mean seeking out those clients prepared to sacrifice returns, or take greater risks, to have impact and providing them with authentic products that achieve that. What it is must not mean is making overblown claims of engagement results. Or using superficial products that appeal to beneficiaries’ desire to make a difference, but which have no plausible additional impact.
While this sounds less ambitious than bold pledges to remake the world, it is better to have a modest goal, pursued with dogged determination and effectiveness, than an ambitious one that is met in perception rather than reality.
[1] See for example J Lukomnik and J P Hawley Moving Beyond Modern Portfolio Theory: Investing that Matters (Routledge 2021).
[2] T Gosling (2024), Universal Owners and Climate Change, working paper, available at SSRN: https://ssrn.com/abstract=4713536 or http://dx.doi.org/10.2139/ssrn.4713536
