Collaborative Engagement in Shareholder Advocacy

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Questions and Answers

What is a key characteristic of universal ownership in relation to investment portfolios?

They can entirely eliminate all types of risks.

They only invest in domestic companies.

They manage a wide range of assets across various sectors. (correct)

They focus solely on high-risk investment environments.

Which type of risk is primarily addressed through diversification according to MPT?

Idiosyncratic risk (correct)

Systematic risk

Financial risk

Market risk

How does universal ownership challenge Modern Portfolio Theory?

It suggests systematic risk can be fully mitigated.

It promotes uniformity in investment strategies.

It advocates for ignoring environmental risks.

It implies universal owners can influence systematic risk. (correct)

What problem might arise when universal owners expect others to address systemic risks?

Free rider problem. Signup and view all the answers

Which of the following is an example of systematic risk that universal owners face?

A market downturn affecting the entire economy. Signup and view all the answers

According to the content provided, what is the percentage range of returns that systematic risk determines?

74-95% Signup and view all the answers

What is one of the limitations of Modern Portfolio Theory highlighted in the discussion?

It does not account for environmental and social issues. Signup and view all the answers

What is the role of universal owners in managing systemic risks?

To proactively reduce risks through collaboration. Signup and view all the answers

What is the primary objective of the Investor Group on Climate Change (IGCC)?

To advocate for climate change policies aligned with the Paris Agreement Signup and view all the answers

Which factor gives investors more leverage when engaging with companies compared to governments?

Shareholding and influence Signup and view all the answers

How does the IGCC engage with the government?

Via hiring a lobbyist to advocate for policies Signup and view all the answers

What is a key difference between engaging with individual companies and governments?

Investors have more formal power with companies than with governments Signup and view all the answers

What is the main goal of the Paris Agreement?

To reduce greenhouse gas emissions and limit global warming to well below 2°C Signup and view all the answers

What advantage does collaborative engagement provide shareholders?

It leads to a consensus view on issues. Signup and view all the answers

What is one of the tools used in the ASCI process?

Voting Signup and view all the answers

Why might management be motivated to engage with investors?

To increase investment and improve share price. Signup and view all the answers

Which of the following actions represents a form of negative screening in ethical investing?

Excluding companies that produce tobacco. Signup and view all the answers

What does the term 'divestment' refer to in ethical investing?

Selling stocks that no longer meet value sets. Signup and view all the answers

What is a characteristic of ethical investors?

They make decisions based on ethical and moral principles. Signup and view all the answers

What challenge does excluding specific sectors pose for a fuel-free portfolio?

Increases the risk and complicates portfolio management. Signup and view all the answers

Which of the following describes positive screening in ethical investing?

Investing more in companies that practice good environmental measures. Signup and view all the answers

What percentage of revenue should a company make from renewable energy to be included in a fuel-free portfolio?

100% with no revenue from fossil fuels. Signup and view all the answers

What is one outcome of successful collaborative engagement among shareholders?

More effective advocacy for shareholder interests. Signup and view all the answers

How does management typically respond to the threat of voting power from shareholders?

By actively soliciting their feedback. Signup and view all the answers

What could be a definition of ethical investing?

Adhering to a specific set of ethical principles while investing. Signup and view all the answers

What type of company would not qualify for a fuel-free portfolio?

A firm that derives 5% of its revenue from gas. Signup and view all the answers

What is a potential negative impact of ethical investing on portfolio returns?

Reduced investable universe Signup and view all the answers

How does excluding companies from a portfolio affect its efficiency?

It can move the portfolio away from the efficient frontier Signup and view all the answers

What does a larger tracking error indicate?

Greater deviation from benchmark returns Signup and view all the answers

Which type of screen is used by ethical investors to exclude certain companies?

Negative screen Signup and view all the answers

What is style bias in the context of ethical investing?

Overweighting or underweighting certain investment styles Signup and view all the answers

How can excluding fossil fuel companies impact investment portfolios?

Reduces income from high dividend stocks Signup and view all the answers

What role does coding play for students analyzing portfolio implications?

It helps view impacts of screens on investable universe and returns Signup and view all the answers

What happens to superannuation funds that exclude entire sectors?

They may face a larger tracking error Signup and view all the answers

What is the purpose of positive screens in ethical investing?

To align investments with the investor's vision and mission Signup and view all the answers

How can divesting from a company affect its stock price?

It may lower the stock price due to reduced investor interest Signup and view all the answers

How does shareholder divestment affect corporate engagement?

Reduces overall shareholder influence Signup and view all the answers

What might be a consequence of a large-scale divestment from a certain sector?

Lack of investment opportunities in that sector Signup and view all the answers

What is a primary concern for financial advisors regarding ethical investing?

Effects of excluding industries on portfolio performance Signup and view all the answers

What is a significant challenge universal owners face when trying to prove the impact of systemic risk management efforts?

It is difficult to link efforts to improved market returns. Signup and view all the answers

What is the primary objective of beta stewardship for universal owners?

To align corporate behavior with the long-term health of systems. Signup and view all the answers

Which of the following is NOT a tool for beta stewardship?

Market manipulation Signup and view all the answers

In the context of universal owners, which aspect contributes significantly to the free rider problem?

Some investors may benefit from efforts without contributing. Signup and view all the answers

Which initiative exemplifies the concept of beta stewardship by addressing environmental impacts?

Climate Action 100. Signup and view all the answers

What is meant by the term 'beta' in the context of universal ownership?

The market as a whole. Signup and view all the answers

Why might investors be demoralized regarding the impact of their systemic risk management efforts?

The impact is difficult to measure and link to market returns. Signup and view all the answers

What is the goal of shareholder activism as exemplified by the resolution at McDonald's?

To address systemic health issues linked to agriculture. Signup and view all the answers

How do universal owners use advocacy in addressing systemic risks?

To influence government and policy for better systemic health. Signup and view all the answers

What was the level of support achieved for the shareholder resolution at McDonald's?

12% Signup and view all the answers

Study Notes

Collaborative Engagement

Shareholders can pool their resources and expertise, making their engagement more effective
A united front from a group of shareholders makes their engagement difficult to ignore
A sense of community and solidarity among shareholders strengthens their advocacy
Shareholders form coalitions, file joint resolutions, and collaborate with other stakeholders to engage with companies

ASCI (Australian Shareholders Collaboration Initiative)

Large super funds collaborate to influence companies
Collaboration fosters a consensus view, making it more credible to companies
Voting and engagement are the tools used
Voting can be used as a threat as directors need 50% shareholder support
The threat of using voting power encourages companies to engage

Investor Engagement and Influence

Investors offer a broader perspective across sectors, while management focuses on internal operations
Investors provide valuable insights on industry best practices
Management is motivated to improve their company for investment, share price, and bonuses
Investors use their shareholder position to influence decisions, communicate views, and leverage their voting power

Introduction to Ethical Investing

Maximizes returns while adhering to specific ethics
Examples include avoiding companies profiting from tobacco or unconventional oil and gas

Unconventional Oil and Gas & Fuel-Free Portfolio

Tar sands and fracking are examples of unconventional oil and gas
Fuel-free portfolios exclude companies making any revenue from unconventional sources
A company with 5% revenue from gas, but 95% from renewable energy, is still considered fuel-free
Banks lending to fossil fuel companies are allowed in fuel-free portfolios
Companies providing services to fossil fuel companies (mining, testing, transportation) are excluded if they make more than 50% of their revenue from it
Companies providing cleanup services for fossil fuel companies are acceptable

Challenges of Fuel-Free Portfolios

Excluding 30% of the investable universe increases portfolio risk
Managing a portfolio with restrictions and certain risk tolerances can be challenging

Ethical Investors

Individuals or institutions making investment decisions based on ethical and moral principles
Avoiding activities or products that clash with their values

Examples of Ethical Investing Positions

Faith-based institutions may exclude "sin stocks" like alcohol, tobacco, and gambling
Funds following Sharia law may exclude businesses selling pork or engaged in lending practices
21st Century ethical funds consider investors seeking ethical products
Other ethical considerations include nuclear power, animal testing, GMOs, and child labor

Screening in Ethical Investing

Also known as exclusion-based investing or norms-based screening
Primary motivation is ethical
Divestment is a type of screening where funds sell stocks no longer meeting their value set
Divestment is not the same as selling for other reasons
Divestment is not about reinvesting in the stock due to price changes

Examples of Divestment

Divesting from fossil fuel companies due to concerns about climate change
Divesting from firearms manufacturers due to gun control beliefs
Divesting from companies with poor human rights records

Impact of Divestment

Puts pressure on companies to change practices
Sends a message to the market about the importance of issues
Leads to a shift in investment towards more ethical options

Divesting from Tobacco: An Ethical Investment Example

Funds divest from tobacco based on ethical reasons and will not buy tobacco stocks, regardless of price
The decision is based on ethics and would only change with a change in the company's behavior or the investor's values

Negative and Positive Screening

Negative screening: Excluding sectors or companies based on ethical considerations
Positive screening: Overweighting companies deemed to be ethical
Example: An ethical investor may negatively screen fossil fuel companies while positively screening those taking climate action

Stewardship in Ethical Investing

Investing in companies adjacent to excluded sectors while using influence to change their behavior
Example: Excluding tobacco companies but investing in supermarkets selling tobacco products, with the aim of influencing the supermarkets to change their approach

Portfolio Implications of Ethical Investing

Ethical investors may use stewardship to influence companies to stop selling tobacco or electrify their vehicles
Screens may negatively impact investment returns due to reducing the investable universe
Removing companies can move the portfolio away from the efficient frontier, increasing tracking error

Tracking Error

Measures the difference in returns between a portfolio and a benchmark
Superannuation funds excluding entire sectors may have larger tracking errors due to the difficulty in matching benchmark returns

Style Bias

The tendency for a portfolio to overweight or underweight certain investment styles or factors
Can be a portfolio implication of screens

Positive and Negative Screens of Ethical Investors

Positive screens direct investment decisions towards the vision and mission of ethical investors
Negative screens exclude companies or sectors that do not align with values

John Dark and Coding

Expert in using coding to analyze the portfolio implications of screens
Students can use coding to see the impact of screens on their investable universe and portfolio returns

Conceptual Understanding of Portfolio Implications of Screens

Generally negative impact on investment returns
Excluding companies can move the portfolio away from the efficient frontier and increase tracking error
Style bias is a possible implication

Tracking Error and Superannuation Funds

Tracking error measures the difference in returns between a portfolio and a benchmark
Funds excluding entire sectors may have larger tracking errors because it’s harder to match benchmark returns

Impact of Excluding Industries on Tracking Error

Excluding industries like fossil fuels, fur, alcohol, and gambling can result in tracking error
The largest impact is from fossil fuels due to its size in the index
Significant index exclusions can increase portfolio deviation

Impact of Excluding Fossil Fuels on Investment Style

Excluding fossil fuels can reduce exposure to investment styles like value
Fossil fuel companies are usually value stocks, with low valuations and high dividends
Exclusion also reduces exposure to high dividend companies, impacting investor income

Considerations for Financial Advisors

Need to understand the impact of industry exclusions on the overall portfolio and the investor's goals
Excluding fossil fuels impacts income for retirees relying on dividends

Impact of Divestment on Stock Price

Difficult to directly link each divestment action to a stock price change
Examples exist where divestment raised awareness and potentially impacted company reputation
Examples are the Scottish university endowment and the Australian National University divesting from fossil fuels

Thought Experiment on Screening and Engagement

If shareholders divest due to ethical concerns, those without those concerns remain
This impacts engagement as remaining shareholders might not push for change
Example: Shareholders divest from a company selling both chocolates and tobacco because of tobacco, leaving behind only those who do not share that concern

Potential Negative Effects of Screening

Large-scale divestment can lead to a decrease in stock price, potentially harming the company and stakeholders
If only shareholders with a specific viewpoint remain, it can impact engagement and the ability to drive change within the company

Universal Ownership and Modern Portfolio Theory (MPT)

Universal ownership is a relatively new concept with limited theoretical foundation
It challenges the traditional financial orthodoxy of MPT
Investors face two types of risks: idiosyncratic and systematic

Systematic Risk

Accounts for most of the returns (74-95%)
MPT suggests that investors can't control systematic risk

Idiosyncratic Risk

Can be controlled through diversification

Climate change, biodiversity loss, water stress, inequality, and social unrest contribute to market risk
These are subset of systematic risk and cannot be diversified away

Universal Ownership and MPT

Universal owners must accept systematic risk, but can use their size and influence to reduce it
This challenges the foundation of MPT as it suggests systemic risk can be impacted

Understanding Universal Owners

Large pension funds or companies managing billions of dollars across different asset classes, geographies, and sectors
They are "universal owners" because they own a diverse range of assets and are affected by systemic risks

Power of Universal Owners

Influence systemic risks through their significant ownership of corporate capital
They can use stewardship and collaborate with other investors

Free Rider Problem

Universal owners might not contribute to addressing systemic risks, believing others will do the work
This can lead to inaction and failure to address systemic risks effectively

Questions for Reflection

Can universal owners influence systemic risk?
Should universal owners take action to reduce systemic risk?

Universal Owners and Systemic Risks

Free Rider Problem: Some investors may benefit from systemic risk management without contributing, but they may be motivated to act if they believe it will benefit their portfolio.
Impact Measurement Challenges: It is difficult to prove the impact of systemic risk management on market returns, as it requires a counterfactual that will never materialize.
Universal Ownership Action: There are real-world examples of investors taking action based on universal ownership thinking.

Beta Stewardship

Definition: Using influence as a universal owner to protect and enhance systems.
Objective: Aligning corporate behavior with the long-term health of the systems.
Tools:
- Engagement: Discussing a company's impact on the broader system.
- Advocacy: Influencing governments and policymakers.

Beta Stewardship Examples

Climate Action 100: Investors engaging with companies to reduce their environmental impact.

Shareholder Activism

Purpose: To influence companies to change for their own sake or their impact on real-world systems.
Tools:
- Voting: Using shareholder power to influence company decisions.
- Shareholder Resolutions: Raising issues within a company.

Advocacy as a Tool for Shareholder Stewardship

Definition: Influencing governments, policymakers, and regulators to protect real-world systems.
Benefits: Addresses issues that impact an entire portfolio and works towards a more sustainable and stable market.

Investor Group on Climate Change (IGCC)

Mission: Advocates for climate change policies aligned with the Paris Agreement.
Members: Institutional investors representing $2 trillion.
Action: Lobbying governments for climate change mitigation and adaptation policies.

Universal Ownership and Government Interaction

Investors have more leverage with companies due to shareholding and influence.
Investors have less formal power with governments but can still influence them through lobbying.

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Description

This quiz explores the dynamics of shareholder collaboration, highlighting how collective actions can enhance engagement with companies. It covers initiatives like the Australian Shareholders Collaboration Initiative and emphasizes the role of voting as a tool for influence. Understand how unity among shareholders fosters effective advocacy.