What is a universal owner?

Laasya Shekaran, CFA

Consultant

LCP clarity:

Many investors focus on company-specific risk within their portfolios, and don’t give enough thought to systemic risk – but systemic factors are the ones that can lead to devastating collapses in economies. To start addressing systemic risk investors can reframe the way they think about their portfolios through a ‘Universal Owner’ lens.

LCP insight:

We can help you look at the wider picture, evaluate whether your portfolio is resilient under different market environments and consider risk in a broader context.

Let’s take a trip down memory lane

It’s 2007.

We’re sitting around in our Ugg boots, listening to a brand new artist called Rihanna singing about how she keeps herself dry when it’s raining, and ‘FAANG’ simply refers to the teeth on the vampires from our favourite book, Twilight - because Facebook has only just been launched, Apple has only just announced the release of its very first iPhone and we are still physically going into Blockbuster shops to pick out DVDs to watch, rather than streaming movies on Netflix. The tech giants comprising of Facebook (now named Meta), Apple, Amazon, Netflix and Google are yet to dominate the stock market.

Yes – I’ve mentioned the stock market, because sadly this article isn’t about fashion or popular culture – any photo of me and my questionable outfit choices from this era will demonstrate that I am in no position to comment on these things.

2007 was also the year of the global financial crisis – a severe, worldwide crisis that led to massive increases in unemployment, people losing all their savings and pensions and even increased rates of suicide.

The factors that led to this financial crisis were complex. It was preceded by a housing bubble in the US, excessive risk-taking by financial institutions and predatory financial products that often targeted uninformed, low income individuals in society.

How to avoid a financial crisis

But what I want to think about today is – what did NOT cause the 2007 financial crisis?

When we think about risk as investors, we often focus on the individual risk of stocks (or other financial instruments) that we hold. Analysts will do a deep dive into every investee company’s financial reports to understand whether that company is too risky to invest in. They will look at the way each holding runs its operations, its cashflows and forecasts and decide how likely it is that company will underperform or go bankrupt – and based on that they will decide whether that company is appropriate to invest in.

Now, this kind of company-specific risk is not the kind of risk that caused the 2007 financial crisis.

The risk that we don’t often think about enough is the much wider and potentially much more devastating risk associated with a collapse in the overall economy: Systemic risk.

Systemic risk is all about the breakdown of an entire system, not just its constituent parts. Rather than looking at whether a company you invest in is likely to underperform or go bankrupt, you think about what could lead to an entire industry or economy going bankrupt.

So how do we start thinking about systemic risk?

In many traditional economic models, such as the ‘Capital Market Pricing Model’ (CAPM) or ‘Modern Portfolio Theory’ (“MPT”), the focus is on company-specific risk and so the focus is around diversifying this element of risk away. These models do not directly address systemic risk – and systemic risk is something you cannot just diversify away, given that it affects a whole economy.

Rather than just applying these traditional models and thinking of ourselves as investors that have a portfolio consisting of certain companies, we need to think of ourselves as ‘Universal Owners’.

The traditional definition of a Universal Owner is a very large, long-term asset owner like a pension fund, sovereign wealth fund or university endowment that ends up owning a more or less representative slice of the economy as a whole – which means that you can’t stock pick your way out of financial crises.

Instead, you need to actively work to address systemic risks, because it is inevitable that they will affect your investments. And not only that – the way you invest and engage with your investee companies will affect the wider world and economy too.

Universal ownership acknowledges the interlinkages and interdependencies within an investor’s portfolio and within an economy. It encourages investors to think about how connected they are with the wider economy, and to address the fact that the externalities caused by one part of a portfolio within a specific sector or company can impact another part of a portfolio.

When the concept of Universal Ownership first started to gain traction, it was mainly used to apply to extremely large, long-term investors such as the Norwegian Sovereign Wealth Fund, or large Dutch Pensions that each cover a much wider share of the pensions market compared to the pension funds we see in the UK. It is undeniable that asset owners such as these fit into that traditional definition of a Universal Owner.

In the UK, pension schemes have not always been considered as ‘Universal Owners’ given the fact that the UK pension market is somewhat fragmented, and as a result, many UK pension funds do not meet the traditional idea of an extremely large asset owner in the same way that a Sovereign Wealth fund would.

However, the important thing to focus on when it comes to Universal Ownership is not just the size of an asset owner, but also its investment time horizon and its exposure to a representative slice of the whole economy.

Any investor that holds a passive, index-tracking equity portfolio can be considered to be a Universal Owner, regardless of their size. Passive equity funds track an index that consists of a large number of different companies. The actions of one company or sector could have an impact on another company or sector within that index. As many pension schemes have moved towards a more passive approach to investing, they automatically become Universal Owners.

LCP viewpoint

The concept of systemic risk and universal ownership all lead back to one simple idea that we don’t give enough time to in our industry: thinking about the bigger picture.

Laasya Shekaran, CFA, Consultant, LCP

The other important consideration is time horizon: if you are a long-term investor, you are going to experience the consequences that arise from financial crises etc that are caused by systemic risk – you do not have the privilege of saying ‘well it doesn’t matter what happens in the future, because that won’t affect me’ (a statement that your future grandchildren may not thank you for anyway!).

The bigger picture

The concept of systemic risk and universal ownership all lead back to one simple idea that we don’t give enough time to in our industry: thinking about the bigger picture.

Because if we consider the bigger picture, we can understand the complex but important factors that cause devastating crises.

If our asset managers, asset owners, investment bankers, politicians and more had truly thought about how one area of the market (in particular, mortgage lending) could impact the wider economy; if they thought about the impact that inequality could have on the stability of the economy – could they have addressed the underlying complex issues that led to the 2007 global economic collapse?

Well, sadly, I don’t have a time machine to find out, so there isn’t a definitive answer to this.

But, what I do have is the strong belief that if we want to avoid the potential collapse of the economy due to really pervasive issues such as climate change, health and inequality we need to focus on systemic risk and we need to consider ourselves as Universal Owners.