Investors’ portfolios are at risk from a warming planet, a challenged social fabric, and many other threats. COVID-19 and the 2008 financial crisis gave us a glimpse of the interdependent nature of our global economy, while the science around matters such as climate change, antimicrobial resistance, and biodiversity loss demonstrates how fragile the economy really is. Ironically, these threats are at least partially rooted in market pressure on companies to maximize internal financial returns, leading to practices that expand company margins but externalize significant social and environmental costs. These costs threaten the systems that undergird the portfolios of these companies’ own diversified shareholders.
Investors have already developed highly effective tools to press companies to optimize their returns. These tools include environmental, social, and governance engagement designed to increase returns and decrease enterprise risk at individual companies. But the company-first lens of current shareholder engagement can’t adequately address extractive company behavior that undermines long-term, broad economic health.
Four elements are essential to system stewardship: a legal foundation, a clear internal mandate, external mandates, and stewardship practices. Below we describe the full range of open-source tools we provide to satisfy each element, including those necessary for internal governance at a fund, creating portfolio-first asset management mandates, and engaging directly with companies.
We invite you to contact us for assistance in using these resources. TSC is a philanthropically funded organization and thereby covers the costs for this assistance. Nothing in this newsletter constitutes legal or investment advice.
Legal Foundation
The Freshfields Report
Although we can’t provide legal advice, a report from the Freshfields Bruckhaus Dehringer law firm, A Legal Framework for Impact, shows that investment professionals around the world have an obligation to prioritize issues such as climate change, poverty wages, and biodiversity loss over the financial performance of individual companies when such systemic concerns provide the greater risk to portfolios. Given the report’s more than 500-page length, we’ve summarized the findings that relate to system stewardship.
Internal Mandate
The Cambridge Principles
The Cambridge Principles were developed following a summit for pension funds, endowments, and experts on social and environmental risks held at the University of Cambridge. The Principles establish why pension funds, sovereign wealth funds, endowments, and other long-term institutional investors (sometimes called “universal owners”) should focus on system stewardship:
Because these funds are widely diversified and their returns depend primarily upon the performance of the financial market as a whole (beta), they can best serve beneficiaries and satisfy their legal duties by preserving the health of the whole economy and the environmental and social systems on which it depends…
Universal owners can most effectively protect their portfolios by working with others to steward companies away from cost externalisation. Without such influence from their owners, individual companies may prioritise their own financial returns, even when doing so threatens the health of vital environmental or social systems or diversified portfolios.
Adopting the stewardship philosophy articulated in the Cambridge Principles provides clear guidance to staff and outside managers and articulates why stewarding the social and environmental systems on which we all depend is in the best interests of clients and beneficiaries.
External Mandates
Asset Management
TSC has developed model language that can be adapted to use in an asset management mandate to ensure the manager is authorized to practice system stewardship. The provisions are designed to complement a mandate that focuses on value at the individual company level, rather than replace it. The language includes the following introduction:
These provisions supplement the portions of an asset management mandate that require a manager to make investment decisions and monitor and steward portfolio companies to improve the relative financial performance of individual companies and actively managed portfolios over both short- and long-term horizons (“alpha”). These model provisions complement that mandate by adding the requirement that an investment manager work together with other institutional investors to protect the social and environmental systems that underpin the performance of all diversified investors and to mitigate risks that cannot be avoided through security selection.
To ensure that alpha does not come at the expense of critical social and environmental resources upon which diversified shareholders rely to support their long-term performance, the principles set forth in these provisions must be given priority whenever they come into conflict with any mandate to pursue alpha or reduce costs.
Proxy Voting Advice
TSC has prepared a Model Request for Proposals (MRFP) that articulates demand for proxy voting advice reflecting the financial impact of company decisions on diversified portfolios. Current incumbents, including ISS and Glass Lewis, provide proxy voting advice that’s designed to maximize the value of the company where the vote takes place, rather than the financial returns of their clients, many of whom hold diversified portfolios. Institutions that own a broad basket of securities need advice that helps them to preserve and enhance the systems that support the entire economy to optimize their portfolio returns. The MRFP includes the following key request:
This RFP seeks advisory services for voting advice that incorporates the portfolio impact of cases in which the effect of a vote on the activities of an individual company is likely to have significant effects on the financial returns of a portfolio that is sufficiently diversified to minimize idiosyncratic risk in accordance with contemporary fiduciary principles (“portfolio-level issues”).
Stewardship Practices
Investment Beliefs & Proxy Voting Guidelines
Adoption of proxy voting guidelines along the lines set forth in this model will give staff and advisors the direction they need to act on systemic issues and ensure trustees have accounted for the full effect of their stewardship choices. We’re currently helping investors to revise their existing proxy voting guidelines to integrate a portfolio-level view.
Guardrails
Guardrails allow investors to establish limits on corporate behaviors that excessively externalize social and environmental costs. While guardrails don’t replace engagement on specific issues, they can raise minimum performance expectations, allowing companies to strive to provide the best product or service efficiently instead of externalizing costs and extracting value from common resources at the expense of their own diversified investors. Guardrails must be meaningful, measurable, and enforceable.
System stewardship involves redirecting the behavior of companies that threaten common resources—not divesting from them. The primary implementation mechanisms for companies that don’t conform to a guardrail are engagement, shareholder proposals, and voting against one or more directors. We’re currently supporting investors in implementing two guardrails: one on poverty wages and the other on antimicrobial resistance.
Proxy Initiatives & Voting
Portfolios on the Ballot (POTB) is the first publication specifically designed to help investors to vote their proxies on a systems-first basis. POTB flags initiatives designed to protect the social and environmental systems that support all the companies in a diversified portfolio. We highlight initiatives that can protect your entire portfolio from individual companies’ myopic choices. Sign up here to receive updates.
For asset owners and managers interested in engaging directly with companies on a system-stewardship basis, TSC provides assistance in crafting shareholder resolutions and engagement campaigns.
We hope these examples will impel investors to implement specific, expert-mediated limitations on corporate practices so that the playing field for business becomes increasingly regenerative and decreasingly extractive.
