A Hard Look at Portfolio-Focused Stewardship

Financially motivated diversified investors want to maximize the overall value of their portfolio and are not independently concerned with the performance of any given portfolio firm. A growing number of scholars have concluded that index fund managers should therefore engage in stewardship designed to force portfolio firms to internalize the costs their activities impose on other portfolio firms (“portfolio-focused stewardship”). This seemingly provides a financial justification for SEC-mandated disclosure on ESG topics—ESG disclosures concerning how a firm’s activities affect the broader economy might help index fund managers identify and, through stewardship, force the internalization of intraportfolio externalities, leading to increases in risk-adjusted portfolio value. This Article critically examines whether, and under what circumstances, financially motivated diversified investors would want their index fund managers to engage in portfolio-focused stewardship, paying careful attention to the real-world frictions that cast doubt on the likelihood that portfolio-focused stewardship would lead to net gains in risk-adjusted portfolio value as well as the alternative tools available to diversified investors for addressing intraportfolio externalities. The analysis has important implications for contemporary debates over SEC-mandated ESG disclosure as well as index fund managers’ fiduciary responsibilities.