Universal Owners and Climate Change

Abstract

Universal ownership theory proposes that widely diversified investors, who own a broad-based stake in the economy, can have a financial self-interest in reducing market-wide risks relating to environmental or social (ES) issues. Universal owner theory therefore provides a way to justify the active pursuit of ES goals, without the need for an explicit ES mandate from clients. This paper sets out a double test for determining whether universal owner theory justifies investor action in a given case. First, the outcome sought should have a credible pathway to enhance risk-adjusted returns at the portfolio level. Second, investors must have efficacy to achieve the outcome without exposing clients to excessive costs and risks. We examine these tests in the context of climate change. When applied to the case of the commonly adopted goal of limiting global warming to 1.5C, universal owner theory runs into problems on both tests. First, the commonly asserted goal of limiting global warming to 1.5C with limited or no overshoot is likely not financially optimal at the portfolio level even on a risk-adjusted basis. Second, even if it were optimal, a review of the finance literature suggests that investors have limited efficacy to affect global warming outcomes. As a result, pursuit of an ambitious global warming goal using tools that are at best partially effective creates the risk of exposing clients and beneficiaries to risks and costs with a low likelihood of corresponding benefits, which could be viewed as being inconsistent with fiduciary duty. Nonetheless, the universal owner arguments may apply in more modest form. We consider the goals that a climate-concerned investors might set and the actions they could take that would be consistent with our tests. We conclude that modest climate goals are more likely than ambitious ones to be consistent with fiduciary requirements and that credible climate action is likely to involve supporting plausible, rather than very ambitious, technological, economic, and political pathways to decarbonisation. Specific investor actions best supported by evidence involves four key areas of focus. First, engagement with companies to encourage them to lean into the net zero transition to the extent consistent with their financial success. Second, positive engagement on policy, both directly with governments but also with appointed asset managers and investee companies to encourage alignment between their own policy lobbying and stated public positions on global warming and targets on emissions. Third, for asset managers work on developing impact and blended finance products that are attractive to clients; and for asset owners modest and bounded impact investments (for example 5% of the portfolio or less) that can credibly be considered as reducing climate risk. Fourth, working to ensure that transition and physical risks are fully incorporated into investment models so as to contribute to ensuring that these factors are properly taken into account by markets. Through targeting a more modest set of ambitions, climate-concerned investors can be more impactful while avoiding conflicts with fiduciary duties to clients.

Keywords: Universal Owners, Externalities, Global Warming, Climate Change, Institutional Investors, Fiduciary Duty

JEL Classification: B26, D62, G11, G23, G34