Capitalism Reimagined | September 20, 2022

Tanking one holding to boost returns and reduce risks across your portfolio

Dan Keeler
Guest Author

Dan Keeler

ImpactAlpha, Sept. 20 – Few big institutional investors would deliberately encourage their portfolio companies to make moves that hit their valuations. 

The Shareholder Commons, a non-profit whose mission is to retool capital markets to support the planet and the people who live on it, believes sacrificing companies that pose systemic risks can protect and enhance the value of diversified portfolios. 

The basic premise is straightforward: The returns that investors with diversified portfolios make are determined more by the overall health of the economy — and arguably, the planet — than by the valuation of any single investment. That gives them a strong incentive to ensure that all companies in their portfolio are contributing to the economy’s overall health, even if that effort is detrimental to the short-term valuation of some of the individual companies. 

Key to Shareholders Commons’ effort is encouraging large investors to collectively establish “guardrails” for portfolio companies identifying activities in which companies should not engage. 

Whether the organization can persuade investors to force portfolio companies to implement strategic changes that would reduce enterprise value remains an open question. The head of Norway’s mammoth sovereign wealth fund seems to be enthusiastic about the core concept, though. 

“If you’re a large investor with a diversified portfolio there is no way that you can run away from these problems,” Nicolai Tangen, CEO of the $1.3 trillion fund, told the FT. “If you have one part of the portfolio that is polluting and destroying the environment, you’re going to be hit in another part of the portfolio.” 

Sara Murphy at The Shareholders Commons says the concept is starting to resonate with asset owners more widely. “Within the next couple of months we expect to be running some pilot guardrails with the full-throated support of some pretty major investors,” she told ImpactAlpha.

In an attempt to kick-start a conversation among asset owners, The Shareholder Commons is today publishing two case studies that support the thesis that investors could use their financial muscle to redirect companies toward socially or environmentally beneficial activities that would create benefits felt across their entire portfolio, even if the value of some individual holdings take a hit.

The studies lay out how shareholder actions that prioritize the health of the overall economy rather than individual companies can tackle the looming threat of antimicrobial resistance (AMR) and the ongoing climate crisis. For example, TSC says, investors are not pushing companies to reduce greenhouse gas emissions in ways that would hit future profitability. “This leads to almost comically perverse outcomes, such as ESG ratings that ignore the GHG emissions of McDonald’s, even though they exceed those of Poland or Hungary,” the study on climate impact says.  

The growing resistance of microbes to medicines such as antibiotics also threatens to drag heavily on the global economy, TSC warns. “Without urgent action, we are heading for a post-antibiotic era in which common infections and minor injuries can once again kill,” the firm says. Covid-19’s economic impact—the pandemic is estimated to have cost around 10% of global GDP in 2021—illustrates how heavy the economic burden of disease can be. That economic burden also affects diversified portfolios, which essentially reflect the value of the global economy, TCS says. 

One key action investors can take is to work together to set guardrails — enterprise value-agnostic standards that apply to all portfolio companies — that all firms in a particular sector will be expected to respect. The strategy recognizes the fact that individual companies are unlikely to behave in ways that protect the overall value of the economy if they stand to lose out competitively by doing so. 

“Rather than engaging with companies to find agreement on how far they can go, shareholders themselves need to set the pace…that will protect the economy overall,” the study says. Investors should agree on specific targets for greenhouse gas emissions or for antimicrobial use levels that protect the global economy, for example. “By establishing such guardrails, shareholders can overcome the limits of decision-making at the company level,” it adds.