Institutional investors who have diversified portfolios can be considered to own a representative share of the entire economy (the ‘universe’ of companies) and especially if they have a long-term horizon, their approach should be built around managing total market value, rather than focusing on the individual components of their portfolio.
Such investors pick up their share of negative (or positive) externalities – the cost (or benefit) caused by a producer that is not financially incurred (or received) by that producer. Thus, the interests of universal investors aligns more closely with that of public at large rather than interests of particular companies, particularly if the focus is on the short-term.
Given their business model depends on the long-term health of the financial system as a whole, universal owners also have a strong rationale for balancing the needs of the present with the needs of the future (aka “inter-generational equity”) and the sustainability of the economy.
Diversified and long-horizon pension funds are the archetypal universal owners. Insurance companies, sovereign wealth funds and index funds can also be considered universal owners if they are well governed and conflicts of interests are well managed.
A good way to understand universal owner theory is by comparison with modern portfolio theory.
| Modern Portfolio Theory | Universal Owner Theory | |
| Goal | To construct a portfolio that maximises expected return for a given level of risk. | To re-couple the financial sector with real-world economics, improve the overall market risk/return profile and direct capital to societal needs. |
| Theoretical underpinnings | Investors are rational, markets are efficient, shareholder value takes primacy, and risk can be diversified away. | Since businesses impose externalities on others, shareholder value is balanced with a focus on stakeholder value and societal value (since third parties, such as the unborn or ecosystems, can be impacted by those externalities). |
| Focus | Idiosyncratic risk – the risk of a particular company – and how to outperform market indices – the “alpha”. | Systemic risk and how to enhance risk-adjusted returns from the market – the “beta”. |
| Key strategies | Stock-picking, ESG integration and engagement to improve share price (“alpha stewardship”). Use diversification such as index investing and asset allocation to minimise idiosyncratic risk by combining assets that are as uncorrelated as possible (ie don’t follow the same ups and downs as other assets). | MPT strategies are still relevant but a defining feature of UOT is collaborative stewardship to safeguard the beta. Alpha that comes at the expense of beta is a disservice to clients and beneficiaries. Collaborative engagement can be focused on a theme (eg climate change or gender) or an industrial sector or an asset class (eg leveraged buyouts) or a whole market. Lobbying regulators & legislators in favour of policies that protect market returns and that create a new level playing field which rewards more sustainable corporations. |
| Implications | Investors ignore or reward companies for externalising costs. If the legal or reputational costs of externalisation are significant, this may concern investors but typically the company will invest in corporate political influence to mitigate any risks and investors will also ignore or reward this (aka “corporate capture”). | Investors seek to prevent companies from externalising costs in ways that harm the financial, environmental and social systems on which the capital markets rely. This includes a focus on corporate lobbying. |
| Advantages | Simple to operationalise – risk equals volatility. Easy to measure the relative performance of individual investment professionals and firms – peer comparisons compared or a widely used benchmark. Easy to manage – reward portfolio managers for beating the benchmark and leave it up to them how they do it (provided its legal and consistent with the mandate). | Takes account of positive and negative externalities and beyond that, also planetary boundaries and social foundations (or thresholds and allocations). |
| Disadvantages | Widely shown to be flawed/limited but this does not currently matter because it has become the basis of the investment industry. Frames systemic risk as exogenous – largely unpredictable and/or something that can, at best, be partially mitigated. Has enabled corporate and executive prosperity to become progressively decoupled from social prosperity and environmental well-being. | Difficult to operationalise and measure – it needs a learning-by- doing approach and requires more sophisticated management. Its theoretical underpinnings are disputed by those with neoliberal worldviews & this includes many investment decision-makers. It is not supported by formal training or cultural norms. For example it requires collaboration between competitors. |
| Supporters | MPT is widely acknowledged by supporting professions including actuaries, investment consultants and investment lawyers as well as regulators. | Advocates include some academics & NGOs and forward-looking investment insiders. A few legislators & regulators are beginning to adopt aspects of UOT. |
Universal ownership is a transformative change which has the potential to shift the rules of the game, so altering company behavior and fundamental strategy and reallocating capital. Whilst the financial sector cannot – and should not try to – replace the role of government, it is clear that without the proactive engagement of the financial sector, real world change will be slower and less effective than systemic risks/threats demand. Asset owners – as the most diversified, most long term and least conflicted institutional investors – have an absolutely critical role to play.
This next decade is crucial with respect to several systemic threats, not least the climate emergency, so the time for universal ownership is NOW!