By Steve Brown
Boris Johnson thinks London is the natural home for asset managers. As an activist investor, I agree it is the only place in Europe with the diversity of skills, experience and nationalities required to implement our highly engaged investment strategy.
But there is one area where the UK’s institutional investors (with one or two exceptions) seem to be behind the curve. Compared with our US peers, we seem oddly reluctant to identify investee companies which present opportunities for enhanced returns because of a stewardship vacuum, and where an engaged shareholder can act as a catalyst for change. Companies, in other words, that are under-delivering, but have the untapped potential to provide better shareholder returns.
There are understandable reasons for this seeming reluctance among UK investors. Frankly, it’s a lot of hassle – the whole process of identifying such opportunities, eliminating the “no-hopers” and actually implementing change can’t be done overnight, isn’t entirely foolproof and is highly resource intensive. Nor is it cheap – the resourcing requirements see to that.
Furthermore, most UK pension funds are increasingly allocating assets away from active options into passive funds in an attempt to save on fees. Given the funding pressures on hard-pressed pension schemes, (and the political pressure, in the case of local authority schemes), this is hardly surprising, and in the long term is unlikely to change.
The downside with passive funds lies to some extent in the very term “passive”. The Collins English Dictionary defines it as “unresisting and receptive to external forces”, while the thesaurus will suggest analogous terms such as “inert”, “lifeless” and “long-suffering”. If you’re building your investment strategy entirely around a passive approach, you may be paying lower fees, but you’re also effectively relinquishing the possibility of exit, and severely constraining the resources that can realistically be applied to improving returns. Arguably you are neglecting your stewardship responsibilities. You may be indirectly exposed to companies with the potential for enhanced value, but you’re not doing anything to unlock that value.
Even mainstream active managers are not really engaging with the companies they invest in. You’re relying on them being a better stock picker than the next person, (and you’re paying accordingly), but they’re generally not engaging with firms to bring about changes in boardroom structure or business strategy, that will lead to enhanced shareholder value.
But we could be missing out if we don’t take a leaf out of the book of the US institutions which are enjoying enhanced returns through engagement. Institutions could run a satellite engagement portfolio alongside a core passive approach to derive the benefits of enhanced returns from a targeted engagement strategy but with very low overall costs. A shift from a conventional approach to a ‘passive + satellite engagement’ structure would offer large cost savings, a clearly differentiated ‘index +’ return opportunity and demonstrably discharge stewardship responsibilities. An innovative construct, perhaps, but as many of the bigger North American funds will confirm, ultimately rewarding.
Steve Brown is CEO at GO Investment Partners
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