Rick Alexander, CEO and Founder of The Shareholder Commons, advises investors to consider the big picture when voting this proxy season.
When asked why he chose to rob banks, Willie Sutton famously (if mythically) responded, “That’s where the money is”. Stewardship teams should follow the same principle: focus on the financial effect that their votes are likely to have on the portfolios of their clients and beneficiaries.
While this might sound obvious, discussions of shareholder proposals and other sustainability-related votes often focus on the financial impact of voting choices on the individual company in question, rather than the financial impact on investors who hold shares within the company. But for a diversified shareholder, company impact is not “where the money is”. The biggest financial impact that many sustainability initiatives are going to have on investors is portfolio-wide, rather than company-specific.
Consider the classic worldwide index of publicly traded companies. The median market capitalisation of a company in such a portfolio constitutes around 0.01% of the total index market cap. That means that a decision that has a 10% value impact on a median company has a US$100 impact on a US$1 million portfolio. But sustainability considerations such as climate, inequality, and biodiversity can have significant impacts on the economy and, consequently, on portfolios as a whole—and that impact is where the real money is for a diversified investor. After all, overall returns are what allow investors to meet their financial goals and liabilities.
While the worldwide index may seem like an extreme example, optimising financial risk and return requires broad diversification. For asset owners subject to fiduciary obligations and the asset managers who serve them, diversification sufficient to eliminate idiosyncratic company risk is mandatory. This diversification means that the most important factor determining investment returns over the long term is the return of the market itself, rather than whether any particular company in a portfolio does better or worse than the market. You need not take our word for this—global legal powerhouse Freshfields has written a survey of the 11 most important jurisdictions for investment, which shows that fiduciaries are generally obligated to adopt a portfolio-forward view of stewardship.
Accordingly, when considering a sustainability-linked vote, the first question investors should ask is, “How will my vote affect my overall return from the market?” In practice, the answer to this broad question may well be the same as the answer to the narrow question, “What vote will optimize returns at the company in question?” For example, the question whether to support a resolution favoring shareholder rights may be “yes”, because those rights will create greater accountability, so that the company is more likely to protect shareholders’ financial interests, improving both company returns and total market returns.
For many sustainability questions, however, the interests of individual companies are not aligned with their diversified shareholders’ interests in optimising overall market returns; it is not always the case that the vote that is best for company returns is best for portfolio returns because the strategy that maximizes cash flows for a company may involve the creation of social and environmental costs – externalities – that threaten the systems that support the economy upon which diversified portfolios depend.
Institutional shareholders can and should vote in the interests of their clients and beneficiaries, even when those interests conflict with isolated company interests. Shareholder stewardship must not be limited to actions designed to preserve or enhance a company’s long-term value. If a portfolio company creates social or environmental costs that threaten their overall portfolio returns, investors should use their stewardship tools to oppose such behavior, even if doing so could reduce enterprise value at an individual company.
In an increasingly complex and interdependent global economy, the optimal strategy for shareholders to achieve their financial goals must include stewardship targeting business practices that put the entire economy at risk. Shareholders must protect themselves from the risk that the companies they own recklessly pursue their own financial success without regard for the effect their business models have on their own shareholders’ diversified portfolios.
The proper pursuit of such system stewardship will mean leaving behind the worn-out idea that shareholders should want companies to solely prioritise their own financial returns. If choosing to maximise enterprise value harms a company’s predominantly diversified shareholders, then it is the wrong choice. The 2023 proxy season includes many opportunities for shareholders to tell companies that they want their capital used in a manner that preserves the critical systems upon which they rely.
Proxy voting guides such as Portfolios on the Ballot highlight votes that address diversified investors’ common interests in a just and sustainable economy. These matters allow shareholders to press for an end to extractive practices that threaten diversified investors’ financial interests in preserving a resilient economy.