Raj Thamotheram is, in theory, betting on pension funds.
Covid has transformed global politics and the Omicron variant has caused markets to tumble. Meanwhile COP26 failed to address, adequately, the urgency of the climate crisis and as the first anniversary of the 6 January storming of the Capitol nears, the future of democracy in the US looks increasingly uncertain.
Can we be hopeful about the future?
Much depends on powerful players who have – so far – sat on the fence. This includes many (but not all) pension funds. Those funds total more than $50 trillion; could they help save the world? Possibly.
Today, however, investors are a primary enabler of dysfunctional corporate and market behaviour so harm-reduction is a crucial first step.
Growth becomes cancerous
The Modern Portfolio Theory (MPT), on which much pension fund investing is based, had a transformative and positive impact on the industry when it was conceived. But that was in the 1950s. The way it has been interpreted since has become deeply dysfunctional.
Its critical weakness is that it rules out the possibility that investors collectively impact systemic risks. MPT has given rise to shareholder-value primacy and fuelled the corporate capture of politics – a combination that has deeply undermined capitalism and democracy.
Vaccine neoliberalism is the order of the day.
Big Pharma is a current example. Vaccine manufacturers today define who they will sell Covid vaccines to, and at what price. As well as five million reported deaths, there have been three to four times that number of “excess deaths”; still more livelihoods destroyed; and major setbacks of all the sustainable development goals. Vaccine neoliberalism is the order of the day. That governments funded the basic vaccine research makes this situation particularly outrageous.
Theory and practice
Thankfully, insider change agents are seeking to bring investment theory and practice into the 21st century. The new theory – Universal Ownership (see table Comparing Modern Portfolio Theory and Universal Owner Theory) – is most suited to large institutional investors who have long-term liabilities and who are exposed to holdings that are widely diversified in terms of sector and geographic region.
| Modern Portfolio Theory | Universal Owner Theory | |
| Goal | To construct a portfolio that maximises expected return for a given level of risk. | To re-couple the financial sector with real-world economics, improve the overall market risk/return profile and direct capital to societal needs. |
| Theoretical underpinnings | Investors are rational, markets are efficient, shareholder value takes primacy, and risk can be diversified away. | Businesses impose externalities on others, shareholder value is balanced with a focus on stakeholder value and societal value – third parties, such as the unborn or ecosystems, can be impacted by those externalities. |
| Focus | Idiosyncratic risk – the risk of a particular company – and how to outperform market indices – the “alpha”. | Systemic risk and how to enhance risk-adjusted returns from the market – the “beta”. |
| Key strategies | Stock-picking, ESG integration and engagement to improve share price (“alpha stewardship”). Use diversification such as index investing and asset allocation to minimise idiosyncratic risk by combining assets that are as uncorrelated as possible (ie don’t follow the same ups and downs as other assets). | As for MPT Plus collaborative engagement generally focused on a theme such as climate change or gender, and/or an industrial sector or a whole market. |
| Implications | Investors ignore or reward companies for externalising costs. If the legal or reputational costs of externalisation are significant, this may concern investors – typically the company will invest in corporate political influence to mitigate any risks and investors will also ignore or reward this. | Investors try to prevent companies from externalising costs in ways that harm the financial, environmental and social systems on which the capital markets rely. |
| Advantages | Simple to operationalise – risk equals volatility. Easy to measure the relative performance of individual investment professionals and firms – peer comparisons compared or a widely used benchmark. | Takes account of positive and negative externalities and beyond that, also planetary boundaries and social foundations (or thresholds and allocations). |
| Disadvantages | Widely shown to be flawed/limited but this does not currently matter because it has become the basis of the investment industry. Frames systemic risk as exogenous – largely unpredictable and/or something that can, at best, be partially mitigated. Has enabled corporate and executive prosperity to become progressively decoupled from social prosperity and environmental well-being. | Difficult to operationalise and measure – it needs a learning-by- doing approach. Its theoretical underpinnings are disputed by those with neoliberal worldviews such as many investment decision-makers. It is not supported by formal training or cultural norms. For example it requires collaboration between competitors). |
| Supporters | MPT is widely acknowledged by supporting professions including actuaries, investment consultants and investment lawyers as well as regulators. | Advocates include some NGOs (see table) and forward-looking specialists. A few regulators are beginning to adopt aspects of UOT. |
Universal owners hold a representative slice of the whole economy. Hence their investment approach should be built around managing total market value, rather than by focusing on the individual components. Universal owners pick up their share of positive and negative “externalities” – the cost (or benefit) caused by a producer that is not financially incurred (or received) by that producer – so they need to pay keen attention to intergenerational concerns and to the sustainability of the economy.
Immunity to change
While the theoretical underpinnings of Universal Ownership have broad support, its biggest challenges are practical.
Today, Environmental Social Governance (ESG) investing is said to account for one in three investment dollars. But the real-world value of this is quite unclear given that much ESG activity is relatively superficial – for example just divesting tobacco – or very heavily weighted to integrating non-financial data in valuation and stock picking decisions. To have more impact, investors need to exercise stewardship by focusing less on chasing ESG and more on using investor rights to persuade companies to change.
Greenwash strategies include making an unqualified executive such as the head of marketing responsible for sustainability.
Stewardship, however, requires different skills from those typically found among analysts or even ESG integration specialists. Those who do assertive engagement well, have often had their initial training in law, diplomacy, campaigning or politics. How conflicts of interests are managed is very important. Without this, it is unlikely that investment professionals will challenge powerful corporate executives or board directors – the career risks are simply too great.
Whether a senior ESG professional reports to the Chief Executive or further down the hierarchy is also important. Greenwash strategies include making an unqualified executive such as the head of marketing responsible for sustainability. And geography plays a part: US fund managers have outsized influence – only three of the biggest 20 managers are non-US headquartered (see figure) and it is well recognised that US investment professionals lag their global peers on some key sustainability issues including climate change.
There are huge differences between the strategies used in engagement to boost share price (alpha engagement) versus engagement designed to lift sector standards (beta or system level stewardship). Both allow reporting of engagement activity, but unless asset owners and their agents can see that they are different, the bias to alpha will remain. The way investment professionals are incentivised will also need to change to support a shift in focus to raising standards.
Who will make it happen?
Jon Lukomnik makes a compelling optimistic analysis of this topic. He highlights several examples (anti-microbial resistance, gender balance, mine tailings and climate change) where universal investing is happening with positive, real-world impact. My own focus, which is complementary to Lukomnik’s, rests on how to bring about the necessary extent and pace of transformation, especially when the immunity to change is strongest. A current example is the lack of global sharing of vaccines described by World Health Organisation Director-General, Tedros Adhanom Ghebreyesus, as “vaccine apartheid”. Relying solely on voluntary insider strategies will not be enough.
Interfaith Center on Corporate Responsibility (North America, stewardship, multiple issues)
The Predistribution Initiative (Global, aligning investment with system-level investing)
Preventable Surprises (International, forceful stewardship, political power of asset management)
r3.0 (international, sustainability reporting, thresholds and allocations)
ShareAction (UK/European, multiple issues incl health, stewardship, fund manager accountability)
The Shareholder Commons (System stewardship through public advocacy, proxy voting, policy change)
Academics and the financial media could highlight how universal ownership differs from traditional investing and ESG investing. Actuaries and lawyers could challenge out-dated investor thinking. Investor bodies could be more assertive with their laggard members – the new bodies such as the UN Principle for Responsible Investing as well as the established ones. Regulators need to do what only they can do. The UK’s Financial Conduct Authority, for example, has made it clear that stewardship is integral to delivering good outcomes for the clients.
Universal ownership needs to become as big an issue as fossil fuel divestment has been.
And concerned pension fund members could do much to improve system-level stewardship. This includes ensuring that legislators push regulators to act – lobbying by financial sector trade bodies against regulation is a significant challenge. For example, financial-sector lobbying against the Financial Transaction Tax was very successful in Europe and in the USA. This means universal ownership needs to become as big an issue as fossil-fuel divestment has been. Thankfully some NGOs look set to play an important role here (see table, NGOs that support universal ownership).
Investing has two legitimate purposes: to provide adequate returns to individuals and to direct capital to where it is needed in the economy. Investors to date have largely ignored the latter and chosen to interpret the former as meaning maximising relative returns. To retain its social licence, the investment industry needs to become a true profession and update its understanding of its social purpose to take account of the climate crisis, pandemics and the drift to autocracy, to name just three systemic threats. Whether this happens depends heavily on concerned members of the public making sure that this investment war is not just left to the generals.
