Thinking Big—The transformative potential of Universal Ownership and Systems Change Investing
ESG, Socially (Ir)responsible ISAs and the Anthropocene. This essay examines a fragmented financial sector and looks to the concepts of Universal Ownership and Systems Change Investing as a foundation for driving truly sustainable investment
Guest Blog by ANDREW GAISFORD
Sustainable finance seemed to be thriving. According to last year’s report from the Global Sustainable Investment Alliance, the sustainable investment market was worth over $35trn as of 2021 and is growing rapidly.
But fresh from Elon Musk’s condemning of ESG (‘Environmental, Social and Governance’) investment standards as a ‘scam’, the recent Financial Times Moral Money Summit triggered another furore in the sector when HSBC’s Global Head of Responsible Investments, Stuart Kirk, delivered a presentation entitled, ‘Why investors need not worry about climate risk’, in which he at one point even asked, “Who cares if Miami is six metres underwater in a hundred years?”.
Whatever can be said about the validity of such claims (see James Murray’s rebuttal of Stuart Kirk’s claims, if interested), it is hard to disagree that the world of sustainable investment appears fragmented and lacking a robust, unifying vision around which to rally in addressing the biggest issues the world currently faces such as climate change, biodiversity loss and rising inequality.
It’s not just that the existing paradigm is failing to bridge the trillion-dollar investment ‘gap’ in the real economy, identified in the Paris Climate Agreement as necessary to achieve the UN Sustainable Development Goals (SDGs). A dive into investment market structure will help to shed light on deeper issues.
I am going to examine here the concepts of Universal Ownership (UO) and Systems Change Investment (SCI). First, I will outline the shortcomings of the current sustainable investment paradigm, then consider UO and SCI ideas and their intersection. Finally, I’ll argue that, together, these concepts provide the best candidate for the unifying vision the investment world needs to meaningfully tackle the all-encompassing social and environmental crises.
The need for a paradigm shift
Elon Musk, for his part, justified his ‘scam’ claims by observing that ExxonMobil (an ‘Oil giant’ and disproportionately large historical contributor of climate-change-inducing carbon emissions) broke into the top ten listings of the S&P 500 ESG Index at the same time that his company Tesla (in his view actively driving the green transition in mobility) dropped out of the index altogether (due to claims of poor working conditions in its factories, amongst other reasons).
Personally, I was similarly perplexed when, in researching for this essay, I discovered that my supposedly ‘Socially Responsible’ Individual Savings Account (ISA) was partly invested in Total, another oil major. Digging a little further, I found that Total’s inclusion in the portfolio was due to its rating as an ‘ESG leader’ in carbon emissions by MSCI—a leading global provider of investment tools and indexes. This despite the findings of a peer-reviewed study which recently uncovered that Total had been aware of its harmful impact on the climate since at least 1971.
Total subsequently adopted policies of denial and delay and between 2015-2019 invested over 15 times the amount of capital in upstream oil and gas production as it did in renewables. The very same MSCI ‘ticker’ that rates it as an ESG leader estimates that Total’s activities are aligned with a global mean temperature rise of over 4°C, stating, “its contribution to catastrophic climate change is higher than most”.
The issue here appears to be two-fold. Firstly, there is a basic misunderstanding of what ESG ratings and indexes set out to achieve, which makes them vulnerable to greenwashing and the mis-selling of ‘Socially Responsible’ ISAs.
In fairness to MSCI, they explicitly state that their ratings are designed solely for the purpose of helping institutional investors assess ESG risks from the external environment to a company’s bottom line, as to enable investors to deploy capital in ways that maximise investment returns. In other words, they are not designed for an ‘impact-first’ strategy.
Crucially, since some investors are interested in particular sectors over others, the ratings are designed to compare companies against their industry peers. Hence why Total are able to be classed as an ‘ESG leader’ in carbon emissions: it’s not exactly competing against an elite field.
However, the tragic comedy of Total’s MSCI ticker prompts the obvious question, what use are—and indeed what guarantee is there of—‘investment returns’ on a 4°C warmer planet?
And here I come to the second part of the issue, demonstrated by the aforementioned Who-cares-if-Miami-is-six-metres-underwater controversy and what Mark Carney refers to as the ‘tragedy of the horizons’: The predominant paradigm compels investors to discount the future, to focus on short-term gains and to socialise long-term externalities (such as carbon emissions).
Calls for measures to reform ESG integration may well be valid, and include a clearer consideration of the three letters individually, a dedicated watchdog to police ESG marketing, and a standardised reporting framework. However, they are incremental at best and miss the overarching point that ESG is failing to bend the emissions curve or create the transformational societal changes necessary.
What’s needed, then, is a truly systemic approach to investment that reverses the current inward ESG focus stressed by the MSCI to instead consider risks posed by companies to society and the wider environment. Some authors say this challenge begins with engaging the largest institutional asset owners, as key actors in the sector with unique characteristics that should be aligned with this vision. This idea is explored further below.
Universal Owners
James Hawley and Andrew Williams were among the first to detail the phenomenon of universal ownership (UO). ‘Universal Owners’ (UOs) are institutional investors (such as pension funds) that are so large, widely invested in multiple asset classes and economic sectors, and sufficiently long-term in their investment horizon, that they essentially own a slice of the economy as a whole. To a degree in fact that it’s becoming impossible for them to diversify away from large system wide risks.
Nevertheless, these huge asset owners tend to look out solely for the performance of the individual investment holdings in their portfolio, even when the above unique characteristics suggest they should be most interested in the economy’s overall long-term health. Social and environmental costs externalised by one profit-maximising company in the portfolio are highly likely to cause even greater costs (such as climate change damages) to be internalised by another company in the portfolio (or otherwise accrued to society as a whole). At some point in the future, this will produce a net financial loss in the universal portfolio. UOs should be motivated to use their influence to mitigate against such outcomes; if not for ethical reasons, it’s very much in the interest of their long-term risk-adjusted returns.
This need not simply mean divestment from badly behaved companies but instead necessitates the type of ‘active ownership’ that includes, for example, publishing ‘mission’-specific policy guidelines circulated to portfolio companies; failure against which may result in punitive action (such as withhold or “vote no” campaigns against board members or CEOs).
Most strikingly, long-term attentiveness to the health of the economy and society as a whole would align UOs ideologically with the public interest at large, and consequently with public policy decision-making. In that vein, UOs should be prepared to encourage policymakers and regulators to promote the public frameworks that will support the legitimacy and effectiveness of the mission-specific guidelines mentioned above.
Indeed, UOs should be broadly in favour of collaboration, including amongst companies and asset owners. For example, while a profit maximising company would be intrinsically motivated to protect their ‘trade secrets’, UOs should encourage pre-competitive frameworks here (such as industry-wide Research and Development (R&D) consortiums and public research programmes), in order to share positive externalities within each of their portfolios and wider society. Similarly, UOs should band together in coalitions such as the Council of Institutional Investors to share expertise and reduce duplication of costs in interventions with particular companies. This would help resolve historical notions of ‘social dilemmas’ and the ‘free rider problem’, whereby one UO may be disincentivised to intervene in a company because the benefits would accrue to all asset owners, while the costs of the intervention (time and resources) only accrue to one.
However, as Steven Lydenberg pointed out, there are issues with the practical implementation of the UO concept: UOs are fundamentally constrained by the tenets of Modern Portfolio Theory (MPT)—the dominant ideology in the investment marketplace, prioritising ‘alpha’ (relative outperformance within the market), over ‘beta’ (stewardship of the performance of the market as a whole).
Of course, MPT is rooted in the neoliberal belief that alpha inevitably begets beta, courtesy of the efficiency of the ‘free market’, with assumed self-interested rational actors and ‘creative destruction’ supposedly leading inexorably to optimal socio-economic outcomes. Such a belief is not only at odds with empirical evidence of market failures that lead to externalities not being internalised appropriately, it is also diametrically opposed to the UO ideal.
Nevertheless, in a review of the Canadian investment ecosystem, Benjamin Richardson and Maziar Peihani point out that the MPT ideology remains to date very well embedded within the core structure of the market and may even be growing in its pervasiveness despite the growth in the number and size of institutional investors, who in theory should identify as UOs. Near-term market-based benchmarks dominate performance metrics; long-term uncertainty is inappropriately discounted, practically out of existence; and there remains a common conflation of ‘fiduciary duty’ as being solely to do with the maximisation of immediate returns based on market price. The UO thesis was deemed to be premature. Similarly, Roger Urwin previously observed that most large asset owners see the UO philosophy as no more than an academic exercise and too impractical to take seriously.
More recently, Ellen Quigley has updated the UO concept with a new systemic lens fit for the Anthropocene and the understanding that the poor preparedness for Covid-19, ongoing lack of biodiversity protections, insufficient climate change mitigation efforts, rising inequality and social justice issues are all interlinked.
Change starts with the reform of the standardised education of ‘Darwinist’ economics in academic institutions, as raised for example by CUSP researcher Simon Mair. The theories held by graduates of these schools of thought can become norm-fuelled self-fulfilling prophesies, even if incorrect. One response is for UOs to harness this same ‘double heuristic’ and band together to manifest their own ideas into the market, says Quigley.
This new focus comes at the same time that Jan Fichtner and Eelke Heemskerk have highlighted the multi-trillion-dollar shift from actively managed equity funds into index equity funds, meaning the ‘Big Three’ (BlackRock, Vanguard and Sate Street) asset managers are now so big that they too have an interest in the performance of the economy at large. Despite the Big Three acknowledging this themselves, the study points out that their stewardship is currently feeble at best, as they continue to support short-termist corporate actions such as massive share buybacks that only serve to deprive the real economy of valuable productive investment.
Meanwhile, while more forceful stewardship of corporate practices is well worthwhile, one of Ellen Quigley’s most important subsequent insights has been to reveal the disproportionate focus of institutional investors on asset allocation in the ‘secondary market’ (i.e., public equity) when in fact the vast majority of a company’s financing is derived from the ‘primary market’ (private equity) during its initial expansion.
This is one of the biggest reasons that divestment and ESG-enlightened stock-picking in the secondary market has had so little transformative impact and can never create truly systemic change on its own, Quigley argues; companies don’t raise new capital once they are already on the stock market (besides rare issuances of new shares), their shares are simply exchanged between investors.
All this means, as a UO, the most impactful thing one can do is to ask oneself how best to intervene at the crucial leverage point in a company’s initial capital raising efforts and/or the transition from primary market to secondary market. UOs could, for example, publicly announce their intentions to only invest in UO-compatible IPOs (Initial Public Offerings), such as in renewable energy companies.
In these ways, UOs are well-placed to be the stewards of another concept receiving increasing attention—that of Systems Change Investing (SCI), which is explored in the following.
Systems Change Investing
Being a relatively new concept, there is a lack of peer-reviewed literature explicitly discussing Systems Change Investing. However, in online commentaries, Frank Dixon derives the notion of SCI from the view of societal problems addressed in the Sustainable Development Goals (SDGs) as merely symptomatic of fundamental flaws in underlying socio-technical systems. Accordingly, SCI describes a shift from a narrow focus on investing in individual company change to investing in systemic transformation that addresses the root causes of these issues—such as current structural practices that hinder intergenerational equity.
An SCI metric used to screen companies for an investment portfolio could include corporate advocacy for systems change; collaboration with other companies, NGOs and academic groups promoting systems change; and corporate embracing of a ‘fiduciary duty’ that includes duty to future generations. However, as Dixon admits, such a ratings framework is more complex than ESG by account of its breadth and relies on developing new data requirements and proxy use.
Meanwhile, a white paper by Dominic Hofstetter sets out a systemic investment logic that rejects a single-asset focus and the financial industry’s predominant objective of merely making money from money. Instead, SCI strategy would seek to catalyse transformational, directional change in the real economy and society as a whole. This involves first mapping the socio-technical system and then identifying the ‘niches’ and ‘nodes’ that can act as high leverage points towards which to allocate capital to propel the system into a new configuration.
At its heart sits a ‘strategically blended’ investment portfolio of synergistic assets that in combination work to unlock a particular directional system change. The asset allocation approach is necessarily dynamic and adaptable in response to the emergent behaviours emanating from the system after initial allocation. In this way, desirable and undesirable outcomes can be respectively amplified or attenuated with further adaptive capital allocation.
Like UO theory, SCI embraces collaboration over competition and calls for partnership with government to influence ‘market-shaping’ that enables the de-risking of the investment portfolio within the wider policy context. Both concepts also admit that more work needs to be done on developing appropriate measurement metrics to capture a new kind of ‘return on investment’ (ROI) not based on market price alone.
However, where there appears to be tension between the two concepts is in their respective approaches to portfolio diversification. UOs remain perhaps too heavily influenced by Modern Portfolio Theory ideas, placing inordinate emphasis on ‘hedging’ as a way to de-risk a portfolio, through the identification of negative correlation between assets. For example, a UO may invest in a luxury goods company that it expects to perform well when wages are high but would suffer if a recession were to hit, while at the same time ‘protecting’ itself by investing in a more ‘recession-proof’ utilities company that albeit might not perform so well in good times. Indeed, as mentioned previously, UOs are characterised by being so heavily diversified that they practically own a stake in the economy at large. By contrast, Hofstetter’s concept of SCI champions a positive correlation between portfolio assets in order to achieve the ’additionality’ and combinatorial effects that produce the powerful systemic changes desired. Nevertheless, UOs can in principle still draw on SCI to create more alignment within their portfolios in both the primary and secondary markets, as well as with their advocacy for wider systemic change within public policy, for example.
Conclusion
In Prosperity Without Growth, Tim Jackson describes the need for a reform of investing, away from its preoccupation with speculation, chasing labour productivity growth and relentless stimulation of novelty-seeking consumption behaviours. Instead, investment should be a ‘commitment to the future’, with capital allocated to carbon-light, employment-rich sectors such as energy efficiency, healthcare and community spaces.
With their outward-facing, systemic focus, Universal Ownership (UO) and Systems Change Investing (SCI) appear well suited to this goal, in ways that existing approaches such as ESG do not. Proponents of both UO and SCI highlight the same kind of long-term, holistic, place-based investment in communities. Moreover, it seems impossible that an index provider could publicise a 4°C warming-aligned Total as an ‘SCI leader’ in carbon emissions.
Nevertheless, more work is needed to develop and mainstream appropriate SCI metrics and UO practices. Furthermore, there is a risk that the lingering influence of Modern Portfolio Theory, and a natural interest, of UOs especially, with the performance of the economy at large, will only serve to sustain a ‘growth imperative’ within the system as a whole; something authors have warned is a destabilising influence. For example, only two years after James Hawley and Andrew Williams wrote that Goldman Sachs and AIG were exhibiting UO-style characteristics in their sustainable investment practices, the same organisations were implicated in the growth-obsessed speculation that led to the financial crash.
Strictly applied SCI may have mitigated such practices and, ultimately, asset owners should acknowledge that truly sustainable investment of the kind discussed above is likely to slow economic growth.
About the Author
Andrew Gaisford is an MSc Sustainable Development student at the University of Surrey with a background in the energy trading sector. He lives in Surbiton and is always on the lookout for new high-flow, low-environmental impact hobbies.
