| Modern investing requires diversification. Optimizing the financial risk and return of a portfolio requires broad diversification. This allows savers to earn the high returns available from risky assets (such as common stock), while diversifying away the idiosyncratic risk that would accompany concentration in one company or sector. Diversified investors must prioritize overall market returns and broad economic performance. This diversification means the most important factor determining investment returns over the long term will be the return of the market itself, rather than whether any particular company in a portfolio does better or worse than the market: overall market performance explains 75-94% of portfolio returns. In turn, the economy’s performance chiefly determines broad market performance. Diversified investors considering sustainability questions should prioritize the systemic effects of company decisions in order to enhance broad market returns. When considering a vote on a matter that implicates sustainability issues, investors should ask, “How will my vote affect my overall return from the market?” Often, the answer to this broad question is the same as the answer to the narrow question, “What vote will optimize returns at this company?” For example, the answer to the question of whether to support a resolution favoring shareholder rights may be “yes,” because those rights will create greater accountability, so that the company is more likely to protect shareholders’ financial interests, improving both company returns and total market returns. For some sustainability questions, however, individual companies’ interests are not aligned with their diversified shareholders’ interests in optimizing overall market returns. It’s not always the case that the vote that’s best for company returns is best for portfolio returns. The strategy that maximizes cash flows for a company may involve the creation of social and environmental costs that threaten the systems upon which diversified portfolios depend. These externalized costs undermine the value of the global economy. For example, an investor might be concerned that an investee company is emitting GHG at a rate that’s inconsistent with a global temperature increase that preserves value across the economy; that investor might choose to vote against directors of the company if it didn’t change its behavior, even if company managers believed the emissions reduction would reduce the company’s financial returns. For in-depth discussion as to how this perspective affects shareholder action regarding climate change, antimicrobial resistance, and wages, see the case study section of our website. Shareholders can and should vote in their own interests (or those of their beneficiaries), even when those interests conflict with isolated company interests. Neither law nor commercial reality constrain shareholder stewardship or advocacy designed to preserve or enhance a portfolio’s long-term value: If a portfolio company creates social or environmental costs that threaten their overall portfolio returns, investors can (and should) use their stewardship tools to oppose such behavior, even if doing so could reduce enterprise value at an individual company. (A memo explaining this concept is available here.) System stewardship is best implemented through shareholder adoption of guardrails. Guardrails are minimum sustainability parameters for companies that protect social, environmental, and economic systems. For example, if investors believe the economy would benefit from a greater percentage of workers receiving a living wage, they could support a guardrail that requires companies to provide such wages throughout their supply chains. Shareholders can use multiple tools to insist that companies pursue profits within these limits: - Voting against directors at public companies that don’t follow guardrails;
- Voting for resolutions asking companies to adhere to guardrails;
- Voting against going-private transactions that don’t include guarantees to adhere to guardrails; and
- Ensuring companies entering the market through IPOs are committed to guardrails.
Investors can also use their influence as limited partners to ensure private equity, venture capital, and hedge fund sponsors bring portfolio companies within guardrails. Even companies not subject to such governance tactics can be affected through their participation in supply chains. System stewardship leverages investors’ unique powers. Some investors who recognize the threat extractive corporate practices pose to their diversified portfolios believe policy advocacy is the best method to address corporate excess. While such advocacy can be useful and important, it doesn’t leverage the unique power shareholders have as rightsholders in companies, which can be particularly important during periods where policy solutions are unlikely. | 
