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Industry Voices

Commentary: Universal ownership – the world’s largest asset owners look differently at investing

Universal ownership is an idea whose time has come. The concept is not new — it was outlined by James Hawley and Andrew Williams as far back as 2000 — but it now is poised to step out from the shadows.

Growing interest in universal ownership is driven partly by strong interest in all things sustainability-related, partly by the emergence and growing influence of huge and outward-looking institutions such as Japan's 150.7 trillion ($1.36 trillion) Government Pension Investment Fund, Tokyo, and Norway's 8.89 trillion kroner ($1.03 trillion) Government Pension Fund Global, Oslo. It is a sign of a fundamental shift in attitude among leading investors.

In a 2011 overview of the topic, Roger Urwin, global head of investment content at Willis Towers Watson PLC, noted that "the core idea of a universal owner is a large institution investing long term in widely diversified holdings." The universal owner recognizes that they own, in effect, a slice of the whole economy. As a result, their approach to investing is built around managing total market exposure, rather than by focusing only on the individual components one-by-one.

This wouldn't make much difference if it weren't for externalities. Externalities are how economists describe the impact of corporations' activities on others. Where externalities exist, everyone acting in their own interest can combine to create a bad overall outcome (think plastic bags in the oceans).

So a company may increase its own profits while having a negative impact on others. The classic example of an externality would be pollution: A company motivated by profit alone will do the minimum required by law (or perhaps even less) to manage its harmful effect on the environment. The company is better off; society as a whole is worse off. These costs fall on others, depressing growth. It turns out, then, that the invisible hand that makes capitalism effective is not underpinned by magic. Rather, effective political and economic institutions are needed to ensure that externalities are dealt with appropriately .

The universal owner is invested in the whole system, so the externalities are internalized elsewhere in the portfolio. The United Nations-supported Principles for Responsible Investment have argued that environmental costs, for example, "are unavoidable as they come back into the portfolio as insurance premiums, taxes, inflated input prices and the physical cost associated with disasters. Social concerns, such as poverty and inequality, can lead to societal and political unrest and instability, which can also create costs that will reduce future cash flows and dividends."

The idea is perhaps best summed up as the returns we need can only come from a system that works.

A different approach

The UNPRI paper goes on to say that, having recognized that the challenge is integrating the impact of externalities into the investment process, the universal owner "gives more weight than traditional portfolio management to intergenerational concerns and to the sustainability of the economy as factors affecting future risk-adjusted returns." This moves the goal posts.

The role of universal owner has implications throughout the investment process: in the governance of the program; in measurement; and in investment decisions at every level, be it asset class, sector or security. Externalities mean that the maximization of long-term returns is not directly achieved by maximizing short-term returns. Investment time horizons lengthen. Extreme risks receive more attention.

As described in this publication in 2017, Japan's Government Pension Investment Fund — the world's biggest pension fund — has explicitly taken on the mantle of universal owner. The result in their case has been a de-emphasis of beating the market and peers, with the focus moving instead onto corporate governance, systemic improvements and the promotion of more long-term decision-making.

The full implications of truly embracing universal ownership are wide-ranging. A 2010 UN Environment Program Finance Initiative paper recommends several specific actions to mitigate externalities, such as encouraging public policies that promote the internalization of costs. A number of the listed actions are to do with improving the quality of data: better identification of the sources of the most significant externalities and of financial exposure to environmental costs, for example.

A more positive role

There is another dimension to universal ownership. Mr. Urwin observes that "it is critical to advance the universal ownership concept using investment beliefs and dispassionate economics," but notes an increasing openness to the view that large asset owners also have a wider role to play beyond finding investment returns. The driving forces behind this increasing openness include the spread of the UNPRI, an expanded opportunity set and, crucially, changing societal expectations — this last factor being increasingly expressed through regulation in many parts of the world.

The case for universal ownership begins with the effect of externalities on the asset owner. But, of course, externalities affect many others too. As Peter Drucker observed almost 50 years ago: "Any institution exists for the sake of society and within a community. It, therefore, has to have impacts; and one is responsible for one's impacts."

So universal ownership provides the beginning of a response to the concern that the prioritization of shareholder value to the exclusion of all other considerations has undermined the legitimacy of the financial industry. If, as Colin Mayer has argued, "we have turned our models of business on their heads and lost sight of what they and we are trying to do," then universal ownership represents a stronger alignment of the goals of the largest investors in the world with the societies that created them.

Or, to put it more succinctly, the benefits we pay are worth more in a world worth living in.

Bob Collie is head of research at the Thinking Ahead Group, an independent research team at Willis Towers Watson PLC and executive to the Thinking Ahead Institute. He is based in Seattle. This content represents the views of the author. It was submitted and edited under P&I guidelines but is not a product of P&I's editorial team.