WWFD (what would a fiduciary do)? A rejoinder to Tom Gosling
Paul Rissman, co-founder at Rights CoLab sets out why he disagrees with the view that asset owners should maintain modest objectives when it comes to tackling climate change
Tom Gosling has published a thought-provoking post, “Why universal owners need modest objectives,” in Net Zero Investor. Dr. Gosling’s influence is great, and through several publications he has become a leading voice casting doubt upon the efforts of universal owners to mitigate systemic investment risk. As a firm proponent of universal owner theory, I feel the need to respond in support of these efforts.
May the reader indulge me in a role play: you are a retirement plan trustee. You have just learned that your technical staff, in running TCFD scenarios, has estimated that “[c]limate change is projected to have a long-term negative impact on a global 60/40 portfolio in the order of minus 10-40% versus a climate-uninformed baseline.” Many of your beneficiaries will be alive and drawing income over this timeframe and risk a greater degree of financial stress than they are currently planning for. What would you do?
If you answered, “nothing much,” you would be in good company. Pension and other fund fiduciaries are hesitant to engage, lobby or divest to diminish systemic portfolio risk. But you may also be breaking the law.
Fiduciary common law in countries with an Anglo-Saxon legal system is flexible, context-specific and designed to evolve as circumstances change. Nevertheless, it is powerful; the fiduciary obligation has been described as “the highest known to the law.” And a key component of that obligation is the necessity to control risk. As the UK Law Commission has stated, “[t]rustees are required to balance returns against risk. This is not a question of maximising returns: risks matter just as much as returns.” In the US, fiduciary law is encapsulated in the Employee Retirement Security Income Act (ERISA), which admonishes pension trustees to “diversify the plan's investments in order to minimise the risk of large losses (emphasis added).” The obligation to diversify, moreover, means that the typical pension fiduciary is a “universal owner” more often than not. The Law Commission recognises the value of diversification as well, but also acknowledges that “diversification guards against firm-specific risk, rather than systemic risk. At times of economic stress, shares tend to fall together, leading to losses in the whole portfolio.” A retirement fund trustee has a duty of care to minimise imprudent portfolio risks, including those that cannot be ameliorated through diversification, like the systemic risk of climate change. And how might fund fiduciaries mitigate systemic risk in keeping with the law? By acting in a reasonable fashion to use the stewardship tools available to them.
Dr. Gosling points to a duet of problems that should discourage universal owners from trying to diminish systemic risk: one, the efficacy of investor action; two, the gap between company and system level effects.
These are problems in practice rather than principle, however. Fiduciaries have recently been quite innovative in using forceful engagement with individual companies to reduce systemic risks. One example is the universal owner California State Teachers’ Retirement System (CalSTRS), the second-largest public pension fund in the US, which has set methane reduction as one of its 2024 priorities. CalSTRS is urging that its portfolio companies join a UN effort to measure, disclose and mitigate methane emissions, to which the oil and gas behemoths Exxon and Chevron have already agreed. CalSTRS backs up its engagement with strong sanction: in 2023 it voted against board directors at over 2000 companies considered to be lagging on climate. Methane has accounted for 30% of the rise in global temperatures since the Industrial Revolution; therefore, this universal owner, and any who join the effort, is reducing the systemic risk of climate change for its beneficiaries.
Another example from the US is the successful campaign that forced Starbucks Corporation to acknowledge workers’ collective bargaining rights. Launched by a coalition of labour unions, and supported by the five New York City pension funds, the campaign utilised recent regulatory changes to nominate a slate of three dissident board directors. The nominations were withdrawn in response to Starbucks’ agreement to work toward a collective bargaining framework with its union. Although the rationale for the board challenge was concern that the company’s anti-union actions “threaten employee well-being, and consequently, the Company’s ability to maximise shareholder value,” income inequality that is at least partially driven by union suppression is now recognised as a systemic risk to the financial markets. Universal owners who support freedom of association and collective bargaining may not only reduce the firm-level risk posed by their investee companies, they will also help to mitigate systemic risk.
The Starbucks example brings up another of Dr. Gosling’s complaints about universal owner theory: that it “provides a horse to which any favoured ESG wagon may be hitched.” In fact, the other “so-called” systemic risks that he names, biodiversity loss and population health (including antimicrobial resistance and access to vaccines), each have severe monetary consequences for the global economy and, by extension, the financial health of savers. Many ESG-related issues generate firm-level risks; others generate systemic risks, and still others generate both kinds. It is an empirical question best left to the economists and other scientists, but is not an inherent defect of the universal owner approach. And lest we forget, systemic risks are interrelated (that’s what a system is).
Finally, Dr. Gosling introduces, but lacks the space to expand upon, the contention that “it is often difficult to prove that taming the [systemic] externality will actually be good for market valuations over the time horizons of interest.” In my humble opinion, this is irrelevant. Systemic risk falls into the category of catastrophic tail risk. Both institutional investors and everyday people try to reduce tail risk to their investments.
But estimating the financial effects of climate change in a catastrophic scenario, and all of the interrelated systemic ramifications, may be well-nigh impossible. Where systemic risk is concerned, it is necessary for a fiduciary asset owner to adopt a precautionary approach. Waiting for the data on market valuations could be catastrophic itself.
Asset managers owe duties of care to their asset owner clients, including mutual funds and ETFs that they advise, and are rightly hesitant to practice systemic stewardship if they don’t know the preferences of their customer base. Retirement fund fiduciaries, however, know at least one preference of their beneficiaries: to not outlive their savings. When this preference is threatened by systemic risk, asset owners must act. By making their obligations known to their managers, and ensuring that their requirements are acted upon, or by engaging with their portfolio companies directly, universal owners can, and actually must, do whatever is reasonable to protect the financial well-being of their beneficiaries. Failure to do so may bring lawsuits. “Nothing much,” is an increasingly indefensible response for a retirement fiduciary/universal owner with the capability to mitigate the systemic risks that their beneficiaries face.
