Capitalism Reimagined | September 2, 2021

Chasing alpha is fine, but long-term returns for universal owners require beta stewardship

Dennis Price
ImpactAlpha Editor

Dennis Price

ImpactAlpha, Sept. 2 – We’re all universal owners now.

Pension and sovereign wealth funds that “own the market” have long known they can’t diversify away global risks. Now even 401(k) account holders and other retail investors are realizing that volatility and value-destruction driven by climate, COVID, inequality and injustice threaten the vast majority of value in their diversified portfolios.

Take, for example, antimicrobial resistance to antibiotics and other drugs, a systemic risk that rivals even climate change. Antimicrobial resistance means more deaths from serious infections resistant to medicine. Unchecked, AMR could cause up to 50 million deaths by 2050 and impact global GDP by nearly 4%, according to the World Bank.

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Any advantage, or alpha, that stock-picking strategies might deliver is likely to be more than overwhelmed by such system-level risks that affect the entire market. That is driving universal owners large and small to find strategies to try to mitigate real-world risks and “negative externalities,” including those generated by companies in which they hold stakes. 

The aim is to reverse corporate behaviors that impose risks on social and environmental systems that negatively impact other companies in their portfolio, and social and economic systems more broadly. 

The new practice of “beta stewardship” goes beyond the identification of risks facing individual companies. The approach also goes further than ESG strategies that promise investors “alpha” returns by parsing companies performance on environmental, social and governance factors. 

“It’s a misunderstanding of fiduciary duty when investors focus entirely on the outperformance of a single stock against a benchmark, instead of the health of the benchmark itself,” The Shareholder Commons’ Sara Murphy told ImpactAlpha. “We’re not maximizing the value.” 

Until now, most investors have largely ignored such systemic beta, the effect on their portfolios of the health of economic, not to mention social and ecological systems, as a whole. It wasn’t that such effects weren’t apparent, Murphy says. It was that systemic risks were accepted as something out of the control or responsibility of any given investor. Attempts to drive outperformance, or alpha, have instead focused on supposedly superior securities selection.

Academic research has shown that the performance of individual companies accounts for only a quarter of the performance of a diversified portfolio. General market movements, or “beta factors,” explain most of a portfolio’s returns.

“Responsible investment in its current guise is not fit for purpose as a means to address systemic risks,” writes Ellen Quigley, an advisor to the chief financial officer at the University of Cambridge as well as to The Shareholder Commons, in her 2020 paper, Universal Ownership in Practice

“Universal owners aim to mitigate systemic risks in the real world, which has the effect of internalizing externalities and protecting the long-term health of the system as a whole.”

Long-term value 

Tackling the looming crisis of antimicrobial resistance requires dramatic changes to global agriculture that go beyond the practices of any single company. More than 70% of global antibiotics today are fed to farmed livestock, accelerating the resistance. 

As in other industries, doing the socially optimal thing would put ag companies at a competitive disadvantage, or cause them to fail. 

“Despite this growing pressure, all companies lack a strategic approach to antimicrobial stewardship that covers all elements of their business,” according to Feeding Resistance from FAIRR, a network of investors addressing ESG risks in the food sector.

Instead, addressing the risk requires an ambitious strategy of beta stewardship. 

“While antibiotic use may be beneficial to the financial performance of individual companies in the food sector, the potential public health risks caused by the overuse of these antibiotics negatively affects the long-term portfolios of diversified shareholders,” writes The Shareholder Commons in its proxy review.

A dozen investors with a combined $7 trillion are gearing up to take on antibiotic abuse in the meat supply chain. The Investor Action on Antimicrobial Resistance launched last year “to scrutinize food and medicine companies’ use of antibiotics before investing, and to engage with businesses in which they already hold stakes to reduce misuse of the drugs.” 

That’s an example of the kind of “guardrails” that practitioners of beta stewardship say universal investors can erect around whole sectors and industries. The strategy doesn’t wait for companies to do the right thing, nor for regulators to step up. Rather, they set industry-wide conditions and enlist industry-wide investors. 

For companies that operate outside of those guardrails, investors can move to deny them new capital, particularly debt, and vote their proxies against corporate directors.

The Shareholder Commons worked with two members of the coalition, Amundi and Legal & General Investment Management, to introduce AMR shareholder proposals this spring at YUM! Brands and McDonald’s with the goal of getting company management to disclose the systemic effects of the use of antibiotics in its supply chain. 

The proposal at YUM! Brands was withdrawn after the company agreed to produce a report. The proposal at McDonald’s garnered support from 12% of shareholders. But the real target for the resolutions wasn’t the companies – it was their shareholders. 

“We actually don’t even think these companies can be properly responsive to systemic issues,” says Murphy. 

In the case of AMR, the argument from food producers has been that responsible antibiotic use will increase disease in livestock, drive up costs and reduce profits. That argument is a red herring, says Murphy.

“Companies need to address the real cause of disease proliferation, which is the confinement model that prevails in most industrial animal husbandry operations,” she says. “We would hope to see them adjust their business models to find a better way of dealing with disease risk in livestock.”

For diversified investors concerned about the impact of public health on the broader economy, says Murphy, the answer is “Ok. That’s a good tradeoff.”