In particular, there is now mounting evidence that inequality is a systemic risk that affects the financial system, the macroeconomy, and the total portfolios of large, diversified investors. Inequality increases the probability of financial crises and, under various conditions, can depress the growth rate of the economy. Inequality is also intertwined with other risks to the financial system, such as climate change, food insecurity, pandemics and other health burdens, polarization and social unrest, corruption, and the erosion of democracy and the rule of law. The largest mainstream investors are diversified owners of thousands of assets, making them significantly more exposed to market risk than to the risk of any one issuer. [emphasis added]

The Institute for Energy Economics and Financial Analysis (IEEFA) released a paper in September 2024 entitled Universal Ownership: Decarbonisation in a Hostile Engagement Environment. Using the term “universal owner” to convey an idea similar to “long-term, diversified investor,” this paper explains the need for diversified owners to engage portfolio companies on systemic issues. IEEFA explains that,

“[u]niversal owners are unable to avoid risks that ultimately affect the entirety of the economic system to varying degrees, meaning they must seek to reduce ‘systemic risk’ to protect beta (market) returns. This will often mean addressing the externalities caused by entities held within the universal owner’s own portfolio.” [emphasis added]

Focusing on environmental issues and the increasingly “hostile” environment in which stewardship teams must operate, IEEFA’s paper highlights what it describes as a “mixed track record” of enterprise value-focused engagement strategies. The report proposes systemic-focused engagement strategies as solutions to the conundrum of engaging a company when a win-win solution is unlikely.

In November 2023, the CFA Institute, Global Sustainable Investment Alliance (GSIA), and UN Principals for Responsible Investment (PRI) released Definitions for Responsible Investment Approaches. These “harmonized definitions” include a definition of “stewardship” that encourages investors to understand that one essential element of stewardship is to “protect and enhance overall long-term value for clients and beneficiaries, including the common economic, social, and environmental assets on which their interests depend.” The definition continues, explaining:

The concept of overall value for clients and beneficiaries is multifaceted. It includes the market value of the entire portfolio (as opposed to individual holdings or individual mandates); the long-term value-creation capabilities of firms and economies; and the common environmental, natural, intellectual, social, and institutional assets that underpin all economies.

International Sustainability Standards Board (ISSB), the international sustainability reporting standard setter, has published a research design paper that suggests they’re open to using a portfolio lens and which also includes sustainability-related financial disclosures that go beyond those relating solely to the company. Our CEO, Rick Alexander, explained the importance of this development in a recent article in ESG Investing:

The [ISSB] paper signals that the international group most identified with financial disclosure is (finally) thinking about closing that gap. This could serve as a critical step in recalibrating the financial system to account for the true cost of the goods and services produced in our economy. If social and environmental disclosures clearly call out the threats that companies are imposing on investors’ portfolios, investors will have the information they need to steward companies away from such conduct, and to address some of the other elements of the financial system that encourage irresponsible behaviour.

As attention and interest continues to grow, we encourage all shareholder proponents to consider adding systemic risk to their engagement materials and to raise these issues during dialogues with issuers, other investors, consultants, and proxy advisors. We can offer direct assistance in developing these arguments.