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A yr in the past, an unknown San Francisco hedge fund with an odd-sounding identify hit paydirt. To the delight of the shareholder activist crowd, Engine No. 1 dramatically succeeded the place others had fallen brief: Humble the mighty ExxonMobil, the Twentieth-century oil and gasoline baron. Within the 2021 proxy season, a majority of its shareholders supported dissident proxy resolutions to elect three administrators nominated by Engine No. 1.
Within the heaven of inexperienced, birds sang and a claxon rang
It was a stunningly well-orchestrated proxy marketing campaign and public relations coup by the best from Wall Road and Madison Avenue, backed by a cadre of subtle asset homeowners and managers, significantly CALSTRS, the second-largest U.S. retirement fund and the Church Commissioners for England. A yr later, Time journal beatified Engine No. 1 as one of many 100 most admired corporations of 2021. GreenBiz knighted its CEO, Jennifer Grancio, the previous COO of BlackRock’s huge iShares ETF enterprise, as considered one of eight badass ladies shaping the way forward for finance and ESG.
The conquering heroes from San Francisco are seen because the de facto face of edgy stakeholder local weather activism and affect investing. Engine No. 1 seeks to take local weather stewardship to the following stage of transparency whereas providing the standard mixture of energetic and passive index funding administration.
Nevertheless, as a brand new proxy season begins, Engine No. 1’s marketing campaign in opposition to ExxonMobil and its enterprise mannequin stay a riddle. Was its burst of activism a cynical try and greenmail ExxonMobil? And did it exploit booming media curiosity in environmental, social and governance points to launch itself as an organization with invaluable PR?
Or was it a watershed second for stakeholder capitalism — a daring instance of “past funding as standard” that challenges the foundational cornerstones of asset administration: portfolio development, safety choice and trendy long-term investing?
Engine No. 1 finds itself in the course of a fast-moving debate on the roles and duties of recent cash managers in a world in disaster.
The reply is neither. As an rising asset administration startup, Engine No. 1 stays a high-profile work in progress. It enters a $100 trillion world cash managing business the place rising social, geopolitical, environmental and well being developments are inflicting a profound rethink by the world’s largest holders of capital on tips on how to greatest develop and handle that capital in a sustainable means within the many years to come back.
And prefer it or not, Engine No. 1, maybe as a result of it has acquired such a disproportionate quantity of publicity, finds itself in the course of a fast-moving debate on the roles and duties of recent cash managers in a world in disaster. That is regardless of the small amount of cash Engine No. 1 manages.
Fashionable Portfolio Concept beneath fireplace
On the heart of the talk is tips on how to perceive and handle the chance of the quickly escalating affect of local weather change and ESG elements on investor portfolios.
Whereas it might be onerous to imagine as we speak, these exogenous elements weren’t thought-about — local weather change didn’t even exist as a difficulty — in Nobel Prize-winning Harry Moskowitz’s Fashionable Portfolio Concept when it was first revealed 70 years in the past within the Journal of Finance.
This issues as a result of Fashionable Portfolio Concept is the near-universal investing orthodoxy for the world’s largest institutional traders. Little identified past the world of teachers {and professional} traders, Fashionable Portfolio Concept (MPT) has guided generations of funding selections by the world’s largest stewards of capital — the enormous institutional pension, insurance coverage and sovereign wealth funds.
Moskowitz’s nice contribution to wealth administration was his perception on the character and significance of portfolio diversification to maximise funding return and reduce funding danger.
The rise of systematic danger and beta activism
Nevertheless, a rising refrain of beta activists argue that there are harmful flaws in Moskowitz’s idea. In MPT, the advantages of diversification apply solely to particular, idiosyncratic danger elements in single corporations or specific property in an funding portfolio.
Nevertheless, lacking from the equation is danger arising from broader systematic dangers. Systematic danger is market danger in investments normally. It’s non-diversifiable and contributes to systemic danger, the chance to or arising from environmental, social or monetary programs. It’s high-order stuff like local weather danger or monetary contagion. It impacts everybody within the financial system. You can’t run. You can’t conceal.
As beta activists, Engine No. 1 went past a conventional proxy struggle and joined the rising motion amongst institutional traders who imagine there may be way more danger than assumed in MPT.
Consider the Nice Despair of the Nineteen Thirties or the Nice Monetary Disaster of 2007-2009 that nearly introduced down the world’s banking system. The foundations and rules after these crises — the U.S. SEC was created in 1934 — had been made to buffer the world’s financial and monetary programs from the varieties of worldwide systemic and systematic dangers that you just can not diversify away from.
Lacking from MPT motion: 75 p.c of all portfolio danger
Of their seminal and good guide “Shifting Past Fashionable Portfolio Concept: Investing That Issues,” Jon Lukomnik and James Hawley argue that the precise danger in a single firm or specific asset has develop into a lot much less important than beforehand thought. They are saying 75 p.c of all danger to an funding portfolio return arises from broader systematic dangers that aren’t included into MPT. “In impact, MPT tells us you could have an effect on what issues least,” says Lukomnik.
Lukomnik and Hawley ambitiously and convincingly synthesize present considering round what known as “programs investing.” Their work and others akin to The Shareholder Commons and The Funding Integration Venture are arguing the investor ought to give attention to a beta over alpha strategy.
The brand new beta activist
That is why Engine No. 1’s struggle with ExxonMobil is so instructive. As beta activists, Engine No. 1 went past a conventional proxy struggle and joined the rising motion amongst institutional traders who imagine there may be way more danger than assumed in MPT.
Beta activists goal systematic dangers at corporations however extra critically at clusters of corporations and sectors in transition, in a quest for higher outcomes for all corporations and stakeholders. Beta activism is about influencing the efficiency of the general funding market. It lasers in on the externalized prices — suppose carbon air pollution or the consequences of smoking tobacco — which corporations foist upon us all. Lastly, it additionally deliberately targets the suggestions loops and the affect of our investments on corporations and the actual financial system.
Beta activism pulls all this collectively and, by doing so, challenges the unthinkable: the holy guide of MPT.
Wall Road’s new masters of the universe
The world’s largest asset homeowners are driving this profound shift in funding considering. They’re diversified Common Homeowners uncovered to the entire financial system — its good and unhealthy fortunes. These traders unequivocally help stakeholder capitalism. They ask corporations to maneuver past enterprise as standard and help a brand new past funding as standard.
What makes these homeowners so completely different is the sheer measurement of their portfolios and that they personal the “complete market” — or about $61 trillion in institutional property worldwide. That’s, they’re most within the total outcomes. They care about broader beta as a result of they’re extra considering systematic dangers than in one-off firm danger. Not by selection, however by definition, they develop into “good residents,” urging actions that do no hurt and profit all stakeholders.
The ExxonMobil proxy struggle was not the primary. Nonetheless, it was undoubtedly the highest-profile instance of how a brand new era of traders is incorporating the next order of exterior dangers — also referred to as “programs investing” — into consideration when managing funding portfolios.
The rise of Engine No. 1
Engine No. 1 is just a really shiny instance of beta activism at work. The agency is the brainchild of veteran Silicon Valley traders Chris James and Charlie Penner, who, with Gancio, did what no environmental activists had succeeded at doing: Rock the interior sanctum of ExxonMobil’s boardroom. They usually did so by enjoying Wall Road hardball.
Armed with Wall Road’s coin of the commerce — an 80-page PowerPoint investor deck, recent capital and years of expertise in activism (Penner), hedge funds (James) and institutional investing (Grancio) — the corporate strategically determined to tackle target-rich ExxonMobil, and by doing so, turbocharged the as soon as nearly apostolic world of earnest funding stewardship.
Chugging into uncharted funding and stewardship territory, Engine No. 1 take a look at drove a brand new mannequin of engaged possession and funding that spoke the language of Wall Road, not the vicarage, however with a heavy inexperienced accent.
ExxonMobil was a goal to not finish fossil fuels or save the world however as a result of it lacked a “profitable and transformative vitality expertise on the Board.” Most damaging for long-term traders was that the ExxonMobil board had did not “place the corporate for long-term worth creation in a altering business and world, and to create worth in a decarbonizing world.”
Engine No. 1 is just a really shiny instance of beta activism at work.
To the shock and shock of virtually everybody, significantly ExxonMobil, the beta activist marketing campaign labored. The upstart gained three seats on the board. It gained, partly, through the use of the identical brass-knuckled techniques of the marauding company raiders of the Nineteen Eighties, solely this time so as to add a brand new inexperienced agenda.
Again then, a “inexperienced” — as in cash — premium was paid by an organization to the raider for its shares, coupled with an settlement to go away. This was derisively often called “greenmail,” a technique utilized by notorious Nineteen Eighties hedge fund traders akin to T. Boone Pickens and Carl Icahn. Others would comply with, storming America’s company citadels to squeeze return and capitalist effectivity out of sleepy American icons.
Engine No. 1, nevertheless, shouldn’t be greenmailing. They and different Exxon activists should not going away. They’re expressing a brand new type of inexperienced investing — name it local weather inexperienced — that believes future investor returns rely much less on jawboning an organization to restructure itself internally and extra on pressuring corporations to grasp and capitalize on exterior inexperienced ESG elements, elements that, like local weather change, the Ukraine conflict or vitality shocks, develop extra critical by the day.
New-age hero with inexperienced knuckles or conventional activist?
That stinging “cash talks, B.S. walks” funding critique, together with utilizing activist techniques hardly ever seen earlier than in sustainability funding stewardship, weaponized stakeholder activism — and obtained the brand new firm the type of priceless PR protection most startups may solely dream of attaining.
“It was ESG activism, nevertheless it was additionally conventional activist exercise,” mentioned Engine No. 1 authorized counsel Elle Klein, a 2022 Dealmaker of the Yr. “Engine No. 1 engaged with Exxon as a result of it was an organization that was underperforming. However it additionally had an important overlay of ESG points.”
So what actually is Engine No. 1?
Regardless of its huge victory over ExxonMobil, what stays unresolved is simply what sort of inexperienced stakeholder Engine No. 1 needs to be. They aren’t a number of pink-capped local weather activists who stormed BlackRock’s New York headquarters at Park Avenue Plaza a number of years in the past.
Nor are they only new-age greenmailers with a conscience. They use activist techniques akin to board director campaigns, however these are coupled with local weather stewardship greatest practices. They’re additionally hearty capitalists, constructing a contemporary funding platform with passive and energetic ETFs, VOTE and NETZ, and a thematic “Perennial Worth” hedge fund.
The founders declare to be forging a new mannequin of energetic possession. The agency’s $750 million property beneath administration are small in comparison with its affect. It hearkens again to an earlier period of investing when small leveraged buy-out outlets akin to Henry Kravis and George Roberts’ KKR had a disproportionate affect on enterprise as standard relative to the variety of property they managed.
So it’s far too early to know if there may be fizzle or sizzle in Engine No. 1’s strategy. Take its enterprise mannequin. There’s little perception into the finer particulars of their “new means of seeing worth” or good knowledge, magic inexperienced funding mannequin. They declare they may ship long-term worth within the context of great alternatives in ESG engagement and local weather options. However so does each ESG store on Wall Road.
Using lengthy SRI coattails and investor local weather collaborations
Way more attention-grabbing is a evaluate of whence they got here and what they’re leveraging, not particular person company-focused beta activism.
The agency is browsing the mainstreaming of the unique Socially Accountable Investing (SRI) wave, pioneered by a era of dogged and numerous activist seers and doers. However it began means earlier than that, within the 1700s, simply as America was rising as a nation and John Wesley first preached “no hurt.”
In that vein, beginning within the Sixties, early SRI leaders focused particular environmental and social points, or in finance parlance, idiosyncratic dangers, akin to these from asbestos, smog, aerosols or weapons, at single corporations or small clusters of them. Specialty SRI funding managers sprung up, investor networks had been organized and sustainable investing began to the mainstream after the SEC issued its first local weather steerage in 2010.
In 2015, the SRI motion, now rebranded ESG, started to select up steam on Wall Road. The Massive Three asset managers, BlackRock, Vanguard and State Road, began to construct “governance and sustainability” stewardship groups and crank out blueprints and whitepapers and, within the case of BlackRock, investor letters from CEO Larry Fink.
Engine No. 1 seeks ‘to flip the institutionalized inertia of siding with administration on ESG points by setting a coverage that helps a overwhelming majority of local weather and ESG proposals on the proxy poll.’
In 2017 the American pension fund CalPERS performed a primary spark function in convening an much more bold world engagement effort for the worldwide trigger of business greenhouse gasoline emissions discount. The next yr, a brand new investor initiative, Local weather Motion 100+, was fashioned and sought to maneuver past idiosyncratic occasions to tackle important industrial sources of public firm emissions. It was a coordinated marketing campaign to handle the higher-level systematic funding dangers posed by unabated fossil gas combustion enterprise fashions.
Seen by many as essentially the most profitable investor collaboration group globally, Local weather Motion 100+ boasts 700 traders, with $68 trillion in property, focusing on 166 corporations, representing 80 p.c of worldwide industrial emissions. It stays a work in progress, however like many net zero initiatives, its uncooked variety of traders and route of journey are spectacular.
A real inexperienced engine?
If Local weather Motion 100+ is the brand new local weather mild inexperienced, Engine No. 1 is presumably a brand new darker inexperienced.
GreenBiz’s personal Grant Harrison, in his article “Can Engine No. 1 assist Wall Road overcome finance inactivism?“, presents that Engine No. 1 seeks “to flip the institutionalized inertia of siding with administration on ESG points by setting a coverage that helps a overwhelming majority of local weather and ESG proposals on the proxy poll.”
Not like the Massive Three asset managers, Engine No. 1 discloses its proxy votes in real-time and points well timed case research on its voting priorities and rationales. Additional, it engages particular corporations on director votes, firm local weather transition plans, greenhouse gasoline target-setting, human capital administration and extra.
Lastly, it has executed what no giant asset managers have tried — to pressure a change in route by immediately difficult an organization’s management.
The rise of proprietor alliances
And whereas jaunty little Engine No. 1 has just lately hogged the local weather activism limelight, the actual engines of change should not hedge funds or Non-public Fairness. Influential, self-proclaimed gold-standard organizations such because the U.N.-Convened Web Zero Asset Homeowners Alliance (NZ-AOA) have emerged over the previous decade, taking a extra world and business strategy to stakeholder engagement.
Albeit with fewer daring headlines than Engine No. 1, these alphabet alliances are main the cost on systematic/systemic danger, beta activism and local weather stewardship, demanding that each one traders, particularly common homeowners, work collectively, deliberately, collaboratively and urgently, to repurpose capitalism to handle the three nice problems with our time: local weather change; inequality; and threats to democracy, as outlined in “Reimagining Capitalism in a World on Hearth.”
Nobody does this higher as we speak than the Web-Zero Asset Proprietor Alliance. With its $10-plus trillion in property, the Proprietor Alliance and supporting refrain climatus of worldwide investor NGOs flash neon inexperienced, turning down goal portfolio temperatures and rising the accountability warmth on its asset managers as world warming intensifies.
Albeit with fewer daring headlines than Engine No. 1, these alphabet alliances are main the cost on systematic/systemic danger, beta activism and local weather stewardship.
Since 2019 they’ve referred to as, with rising specificity, for internet zero GHG emissions by 2050 and funding portfolios aligned with a most temperature rise of 1.5 levels Celsius above pre-industrial ranges. Many agree with this directionality, even when they imagine that 1.5 C is already out of attain.
The most recent blast from the Alliance, “The Way forward for Investor Engagement: A name for systematic stewardship to handle systemic local weather danger,” launched final month, is a clarion name for asset homeowners and their managers to “change the principles of the sport” which have guided institutional investing for 70 years.
Now what?
How all this interprets into investor motion stays to be seen. However the 2022 proxy season is already shaping up into what ought to be a season of escalating investor and firm drama.
Oddly, Engine No. 1 is taking a decidedly low-key strategy on this yr’s proxy fights.
As an alternative, taking up ExxonMobil is the Dutch NGO activist Comply with This. It has filed a proxy decision that requests Paris-consistent emissions reductions targets. It seeks to stoke a shareholder revolt in opposition to ExxonMobil for its “refusal to set Scope 3 targets,” which majorities supported at Chevron, ConocoPhillips and Phillips66 in 2021. Exxon, it says, “particularly rejects accountability for the emissions of its merchandise by calling Scope 3 accounting strategies ‘duplicative and flawed.’”
So why isn’t Engine No. 1 following by way of on all its fireplace and brimstone of final yr? Cynics might argue that they’re simply good previous Wall Road opportunists wearing inexperienced sheep’s clothes. The worth of their stake in Exxon has surged because the cussed oil Goliath just lately predicted file first-quarter income.
Potential, however uncertain. Urged on by long-term considering institutional traders, it’s extra probably that Engine No. 1 is simply the primary of a brand new period of beta-focused funding managers figuring out, partaking and attacking a giant unhealthy bundle of systematic dangers to speed up motion, protect the hard-earned financial savings of tens of millions of pensioners and proceed to outline what’s past funding as standard.
