An oil-soaked cormorant after the Exxon Valdez oil spill in Alaska in 1989. Photo by Paul Fusco/Magnum


Stock-picking for humanity

Everyone on the planet has a stake in making investment more ethical. What’s new is that they have the power to do so too

by Ellen Quigley + BIO

An oil-soaked cormorant after the Exxon Valdez oil spill in Alaska in 1989. Photo by Paul Fusco/Magnum

In 1947, Wilma Soss rose to speak at the annual general meeting of US Steel, asking the corporation to take the unusual step of appointing a woman to the board. The gentlemen declined, and showed their displeasure at Soss’s temerity. But, as she said later, ‘if they had treated me better there would have been no Federation of Women Shareholders’ – the organisation Soss founded soon after the incident.

Soss continued to use flamboyant tactics to make a point at AGMs, including in 1949 showing up in Victorian dress – a large purple hat, a two-piece grey suit, and a lacy blouse (‘The costume represents management’s thinking on stockholder relations,’ as she put it). Soss’s antics were among the first modern instances of environmental and social shareholder engagement, involving tactics that – quite unbeknown to those who opposed her – would usher in a form of investor activism that continues to the present day. Sadly, Soss also inaugurated a concomitant tradition: that of shareholders’ having little to no real impact on the companies they pressure.

Since 1947, the ownership structure of the financial system has changed dramatically: pension funds – either directly or through their fund managers – now control a much greater proportion of companies such as US Steel than do individual investors like Soss. Shareholder engagement has become much more widespread, as have other strategies designed to produce positive social or environmental outcomes. Practices such as divestment (selling investments in particular companies or sectors), positive and negative screening (refusing to own certain harmful companies or sectors, or actively seeking out good companies), and other forms of so-called responsible investment or environmental, social and governance (ESG) investing have proliferated. There’s one unfortunate commonality among them all: most of it doesn’t work.

This is a desperately depressing conclusion to face up to at a time of overlapping social and environmental crises: climate change, mass extinction, growing income and wealth inequality, and the COVID-19 pandemic, just to name a few. Responsible investment has been rearranging the deckchairs on the Titanic for decades now, using the wrong tools to the wrong ends. What if there were an alternative that made better use of the efforts of people like Soss?

You’d be forgiven for knowing little about the sometimes arcane practices of the investment world. Let’s say you own a share in Exxon, the US oil and gas major. This means that you own a tiny fraction of the company. Exxon is listed on the stock market, meaning that its shares are ‘publicly traded’: that is, a member of the public can quite easily buy or sell a share in the company. For a publicly listed company such as Exxon, its shares will be traded on what’s called the ‘secondary market’. When Exxon’s precursors listed on the stock market in the first place, they would have received the proceeds of the sale of their shares; these were ‘primary market’ transactions. Since then, however, Exxon’s shares have traded between shareholders, with the money passing hands among them instead of feeding back into Exxon’s coffers. This is an underappreciated point for wannabe responsible investors and their fund managers, who tend to focus their efforts on large companies that are listed on the stock market: for the companies, it doesn’t really matter when and to whom their shares are bought and sold, provided they’re not publicly embarrassed by the announcement of a morally motivated sale (such as through a divestment announcement).

What’s the point of responsible investment as it’s currently practiced, then? Well, it’s relatively good at identifying environmental and social risks to the portfolio – it’s just not good at actually mitigating these risks in the real world. Think of it this way: if you’re trying to protect your portfolio’s returns against climate risk, and you’re a shareholder in Exxon, you might want the company to increase the height of its ocean oil platforms to account for sea level rise (as they have done, in fact). But if you want to actually mitigate climate change, you might prefer Exxon to decrease its outsized emissions. These are dramatically different lenses to apply to responsible investment. One is about mitigating risk to your returns, while the other is about mitigating real-world risks and harms. For those who want to have a positive environmental and social impact through their investments, responsible investment is facing the wrong way entirely. And even if you’d rather protect your portfolio than do good, there’s no way to do so in an ever-heating world. Responsible investment can’t even deliver its central promise in the long term, when there will be no such thing as protecting a portfolio against catastrophic climate change.

There’s some good news in all of this, though, as a group of unlikely heroes is waiting in the wings. Universal owners are large long-term investors who own a diversified portfolio – pension funds, sovereign wealth funds, or university endowments, for example. They control a majority of global capital markets, and have no choice but to worry about ‘externalities’ – the costs that companies impose on the rest of society but don’t pay for themselves, such as climate change or inequality. Any company or sector that succeeds at the expense of the rest of the market runs counter to the interests of a diversified investor. In the case of fossil fuels, universal owners might not want to support a business model that depends on increasing capital expenditure in ever more remote, dirty and expensive reserves, because this would cause warming that harms the returns of almost everyone else. A universal owner might or might not want to own Exxon herself, but either way she’ll want the company to decarbonise – by winding down its operations over time, or by transitioning into a different sort of company. Her portfolio will be affected, positively or negatively, whichever route Exxon takes.

Even a small drop in support for re-election is embarrassing for the high-status individuals in such roles

Similarly, inequality depresses overall economic activity because low-income people spend a greater proportion of their salaries than do their wealthy equivalents, who tend to save much of their wealth or invest it in the secondary market instead. Evidence suggests that dissatisfaction with democracy rises with inequality, too. Universal owners who own shares in large-scale employers of low-income people – such as Walmart or McDonald’s – are better off if these companies pay their workers a living wage. Even if this means lower returns from investments in Walmart or McDonald’s, that’s better than the economy-wide dampening effect of widespread low-wage earners. If there’s any investor who should want to reduce externalities and mitigate systemic risks, it’s universal owners, who can’t stock-pick away from their attendant harms. An individual Walmart investor (albeit one with no moral compunctions) might prefer to minimise the company’s payroll costs, but she doesn’t have to account for effects on other companies. Universal owners do.

If universal owners’ interest lies in addressing these collective failures, and all of the tools of responsible investment have been available to them for decades, then why is the planet continuing to warm, and why is inequality increasing?

One reason is that responsible and ESG investing is almost entirely confined to public equity – shares in large companies listed on the stock exchange, where shares are traded between investors but the cash doesn’t flow back to the company itself. That means there needs to be a different strategy in the secondary market, compared with the primary market where the company itself raises money.

In the primary market – in which investors and banks provide new capital to companies in the form of loans, bond issuances or venture capital – a very different set of tactics apply. In the secondary market, evidence suggests that many of the most commonly deployed shareholder tactics aren’t particularly effective. Shareholder resolutions – which involve submitting proposals that all shareholders can vote on at company AGMs – are largely advisory in nature, not binding; even if a majority of shareholders vote for them (which is rare), the implementation rate is poor, especially for those that go beyond simply disclosing something (such as the company’s emissions or the number of women in senior leadership positions). Disclosure itself doesn’t appear to correlate reliably with improved environmental performance, so the rare win – plus even rarer implementation – is unlikely to deliver results either. Likewise, evidence about the environmental or social impact of communications between shareholders and the company on social and environmental issues is scant and inconclusive.

However, there are a few rarely used (yet cheap and widely available) tactics that tend to be more effective. This includes voting against the directors of companies, which can prompt change more reliably. One need not even win the vote, as even a small drop in support for re-election – even if it remains above 90 per cent – is often viewed as embarrassing by the high-status individuals who tend to occupy such roles. The Shareholder Commons, an NGO, recommends the use of ‘guardrails’ to ensure that companies follow appropriately ambitious decarbonisation plans, pay workers a living wage, or maintain a diverse executive team and board of directors, for example. Falling below these standards would then trigger a vote against the company’s directors.

This sounds like the nuclear option: it threatens board members’ roles and publicly embarrasses them in the process. But the result could in fact be to make the average board member’s job – and that of company CEOs – easier. Just as across-the-board regulations level the playing field so that competitors don’t gain an advantage by sidestepping the rules, guardrails should be a relief to those running businesses in the age of externalities. No longer do they have to compete at the expense of the planet’s atmosphere or the wellbeing of workers. Currently national regulations and laws can’t follow multinational companies across international boundaries, but investments can and do.

Yet instead of pursuing guardrails or making use of director votes, most responsible investing confines itself to stock-picking in public equities. If we’re lucky, it might include some proxy voting and shareholder engagement (usually requesting disclosure only) on the side. For the majority of people who’d prefer to address this century’s growing emissions and social inequities, it would be hard to select a less effective set of tools from among those that are available to an investor.

To be fair, fossil fuel divestment is different. The divestment movement kicked off at Swarthmore College in Pennsylvania in 2011, then rapidly accelerated with the launch of the campaign in November 2012. By the end of 2020, funds representing $14 trillion in investment had divested from fossil fuels – including my own institution, the University of Cambridge. Investors don’t usually divest from fossil fuels because they think it will take money from these companies’ wallets; they do it because they believe that it’s financially prudent to do so and/or that they’re laying the groundwork for the legislative change we ultimately need in order to address climate change. Human societies don’t tend to restrict or regulate products or conduct unless they’re viewed as reprehensible or damaging in some way. As a wealthy and powerful sector, with significant lobbying power at its disposal, fossil fuels are likely to win the day legislatively – indeed, fossil fuels are still actively subsidised the world over. By stigmatising fossil fuels, the divestment movement aims to change public (and politicians’) perception of emissions-intensive companies, and so remove their moral licence to operate.

There’s already evidence that divestment has changed the public conversation, bringing phrases such as stranded assets and unburnable carbon into the lexicon. In most countries, the public appears to be turning against fossil fuels and looking favourably on ambitious plans to stall the advance of climate change. If successful in bringing about changes to laws and regulations, the resulting decline in fossil fuel consumption would affect all fossil fuel companies, not just those that are listed on the stock exchange. So while selling listed companies’ shares doesn’t normally affect companies directly, if it’s announced publicly and produces a global shift in the moral perceptions of these industries, then divestment can chart a different route towards efficacy.

Still, it’s a shame that divestment campaigns tend to focus on public equity, because – perhaps surprisingly – divestment can be directly effective in other asset classes, such as fixed income (bonds/debt) and private equity (companies not listed on the stock exchange). In these cases, the real-world and symbolic impacts of divestment align; evidence suggests that there is what’s called additionality in asset classes other than public equity – additional investment actually contributes to companies’ and projects’ ability to expand or build new infrastructure (renewable or fossil fuel-based). The divestment movement has already decreased the amount of capital (in the form of loans and bonds) flowing into fossil fuels, a 2019 study suggests, and additional investments in initial public offerings (IPOs) and private equity can increase the amount of capital available to companies and thereby facilitate their expansion. So it really matters what you buy in the primary market. The stock-picking tactics of responsible investment – purchasing the shares of certain companies – would be better applied in the primary market, in bonds, venture capital and private equity portfolios.

The result of universal owners’ positive intervention would be de facto ESG for everyone

Indeed, approximately 90 per cent of new external financing for fossil fuels comes from debt – so investors who buy fossil fuel companies’ bonds or work with banks that lend to these companies end up actively contributing to increased greenhouse gas emissions. In fact, banks are massive contributors to fossil fuel expansion: almost two-thirds of new capital for fossil fuels comes in the form of bank loans, and of course banks underwrite new bond issues and IPOs as well. A responsible investor with a genuine focus on mitigating climate change would attend squarely to the banking sector – both as a client and as an investor. These institutions are primary market financing machines, and this is where the new money is coming from, folks.

Maximising the effectiveness of responsible investment demands a laser-like focus on new money and new fossil fuel infrastructure. The former is what powers fossil fuel exploration, extraction and combustion; the latter locks them in. Venture capital (finance for riskier, early stage companies), followed by private equity and, later, an IPO – the evolutionary path of many a fledgling company, in that order – is what facilitates the growth of a firm, whatever its impact on the climate or human welfare. Bonds and loans feed the beast along the way, but especially once a company is established on the stock market. Universal owners can interrupt this evolutionary chain for climatically harmful companies.

Having an impact doesn’t involve stock-picking within public markets; it involves changing the composition of the stock market by controlling which companies gain support along the way to being listed in the first place, and which are permitted to grow through easy access to debt thereafter. The result of universal owners’ positive intervention would be de facto ESG for everyone; even unconcerned investors who tracked the market as a whole would become invested in more ‘green’ companies, as they’d make up a greater proportion of listed companies as a whole. On the bond side, investors would automatically contribute to the new green economy instead of passively investing in the emissions-intensive status quo.

As a species, we’re facing an unusual confluence of crises that can’t be addressed by attempting to protect individual companies and portfolios. We don’t have the time for stock-picking in the secondary market – unless it involves highly publicised divestment announcements, which can act to generate the political and public will to regulate and restrict fossil fuels. Nor can we afford ineffective shareholder engagement and voting. Universal owners control enough of the market to be capable of creating ‘guardrails’ – sets of common expectations for companies that demand reductions in economy-wide environmental and social harms, enforced through votes against the re-election of board members. In the primary market – bonds, loans, private equity, venture capital and so on – it actually matters what universal owners own, as their investments can help the companies in question, so a strict filter must apply. As clients of and investors in banks, the most significant purveyors of new financing, universal owners have a role to play in redirecting capital flows away from fossil fuel expansion and infrastructure to avoid ‘locking in’ growing greenhouse gas emissions. Insurance companies are critical nodes in the system as well; without insurance, a coal plant can’t operate, and neither can a company. In short, universal ownership is evidence-based responsible investment; it aims to mitigate risks and harms, not just to avoid them.

If you believe that you can insulate yourself from the macroeconomic and sociopolitical effects of inequality and from the ever more severe effects of climate change, and that your pension fund can do the same, universal ownership isn’t for you. But if you suspect that your fate is tied up with that of other human beings and the planet we live on, as the pandemic harshly reminded us, you just might want to think of yourself as a universal owner. If you do, you’ll know to switch banks, to bother your pension fund to apply ethical exclusions to its bond portfolio and to vote against the directors of problematic companies (especially banks and insurance companies), and tell everyone you know to do the same.

Wilma Soss would probably be frustrated that it’s taken us so long to arrive at a set of tactics that work. But at least she’d be pleased to see that the number of women on the boards of major companies has finally risen in recent years – following investors’ moves to vote against the re-election of directors on that basis. As a pioneer in shareholder engagement, she didn’t have the benefit of decades of evidence on the efficacy of the tactics available to her. But we do. It’s time for universal owners everywhere to make proper use of what works: excluding polluters and owning only ‘good’ companies in the primary market, where it matters, and voting against directors in the secondary market. In her day, Soss was canny enough to wring the odd concession out of a business she targeted; in our day, universal owners could genuinely change the trajectory of the greatest threats the world faces.