Over the last few decades the frequency with which investors can obtain information has increased rapidly. Not only are stocks traded far more often and easily because trades are done electronically, but institutional investors can monitor the value of their portfolios on a daily basis. Elsewhere, quarterly company reporting and a poor economic backdrop has put pressure on institutional investors to focus on short-term results which is often at odds with their long-term investment horizons.
“Ultimately companies should do what their owners ask them to do. Chief executives are employees of their shareholders.”
Saker Nusseibeh
And so it was that in June last year business secretary Vince Cable commissioned Professor John Kay to examine how the UK equity market should be structured to benefit investors, savers and companies. Kay’s final report, published in July, concluded short-termism is an underlying problem in the UK equity market and that restoring relationships built on long-term trust and confidence, as well as realigning incentives across the investment chain, was a much-needed shift in the culture of the UK market.
Kay’s key recommendations included: establishing an investor forum to encourage engagement by investors with UK companies; applying fiduciary standards more widely within the investment chain; the adoption of ‘good practice statements’ by company directors, asset managers and asset holders; and relating directors’ remuneration to long-term sustainable business performance and asset managers’ remuneration. For the most part, the review was welcomed by the industry but some believe it had omissions and areas it could have explored further.
Top of the chain
At the core of the review and the UK equity market structure as a whole is the convoluted investment chain, which separates companies at one end from their ultimate owners – savers and pension fund members – at the other.
A key part of the review is a recommendation to restore relationships of trust and confidence in the chain by applying fiduciary standards more widely within it. However, according to industry sources, Kay’s review lacked sufficient attention on those at the top of the investment chain – the asset owners – instead focusing more on the role of asset managers, who in reality simply act on the instruction of the asset owners.
Hermes Fund Managers chief executive Saker Nusseibeh explains asset owners are important because we live in a community influenced by large corporations traditionally controlled by majority shareholders who are often pension schemes and insurance companies. This means that ultimately the members of those pension schemes are the owners of those companies and thus makes asset owners crucial to the investment and equity ownership chain.
“Ultimately companies should do what their owners ask them to do. At the end of the day, chief executives are employees of their shareholders,” he says. Asset managers, while also occupying a key role in the process, merely act on the instruction of the asset owners.
Nusseibeh also believes Kay perhaps focused more on asset managers to avoid a political point around whether UK investors should own more of their country’s plc. He says investors are progressively beginning to own less UK plc because of a combination of de-risking, regulation and actuarial practice.
Nusseibeh says: “Given what we have gone through since the crisis should we not reconsider whether we should control British plc? We as a society think there is a place for us to think of companies not just as investments but as stakeholders in our society. Kay did not go down that route because it is political and therefore difficult. He then concentrates on what he can, which is the fund managers.”
Governance for Owners partner Simon Wong also believes Kay could have paid more attention to asset owners, saying an opportunity was missed by not suggesting asset owners reform their governance structures so they play a more active role in the investment chain. This, he adds, is because there is a lack of relevant expertise and knowledge at board and management level at most UK pension funds.
“This could include managing money in-house so you shorten the chain of intermediaries or better monitoring of asset managers,” adds Wong.
However, a large proportion of pension funds in the UK are small and simply do not possess the capabilities to make high level strategic investment decisions, let alone manage their investments in house. That is why, Wong believes, it is time to encourage industry consolidation in order to get scale and hence greater resources to hire in-house capabilities.
The idea of consolidation has been thrown around the UK pensions market for some time now. Negotiations are ongoing around merging London’s local authority pension funds into one super fund, while elsewhere the National Association of Pension Funds (NAPF) has pushed multi-employer ‘super trusts’ as a panacea for the cost and risk associated with occupational pensions.
“It absolutely makes sense from the context of super trusts – if you have bigger funds you have more resource to do things in the interest of the trust’s members,” says NAPF head of corporate governance David Paterson.
The aim of such an approach is about limiting the length of the equity ownership chain and how efficiently each pound of investors’ money works its way around the system which, once all parties involved have had their cut, does not leave a lot.
“If you enact reforms in the pension fund space you could change where assets are managed, how they are monitored and how reliant you are on external consultants as he [Kay] talks about how long the equity ownership chain has become,” adds Wong.
Investor appetite
It is all well and good saying asset owners should have been given more focus in the report but aside from lacking the in-house capabilities and knowledge, do they actually want to be active stewards in the investment chain? Not according to Aviva Investors corporate governance adviser Anita Skipper who believes pension funds need to start showing more appetite for corporate governance.
“Pension funds don’t show much interest in stewardship so it is very difficult to provide the supply without having the demand,” she says. “Fund managers will do it if the demand is there.”
Skipper says one thing she would have liked the review to have done was to encourage pension funds themselves to write into their statement of investment principles (SIP) whether they apply the stewardship approach to investment and if not, why not. Furthermore, she says pension funds themselves should report to their own members about what they are doing in relation to stewardship.
Skipper says: “I am always mystified by the disconnect between the general public who is up in arms every time there is lack of integrity at banks but don’t realise they have the power through their pension funds and part of it is because pension funds never report to their members these issues.”
Russell Investments director, relationship management, Mike Clark echoes this call for a brushing up of funds’ SIPs. “Maybe we need to tighten up SIP regulation,” he suggests. “Could Government require trustees to do more and be more transparent? In regulatory terms the UNPRI [United Nations Principles for Responsible Investment] was voluntary for five years but now something is mandatory.”
Meanwhile, NAPF’s Paterson argues pension funds have been faced with a series of demands over the last 10 years with changing regulation and escalating deficits but for their part in the investment chain they need to be conscious of the need to ensure their agents are doing the jobs they are being employed to do and to assess the calibre of those agents.
“It is a question of putting in place a good oversight structure which involves the use of consultants as well as trustees and managers. Can it be better? I think it probably can but there are an awful lot of funds out there so there is no consistent industry standard,” says Paterson.
Reaching globally
According to Russell Investments’ Clark, it is also important to see the issue in a global context. To be fair to Kay, his remit was purely to look at the UK equity market as per Vince Cable’s wishes but with stock markets being international in flavour these days it is difficult not to factor global equity markets into the equation.
Clark says: “You have to see the problem in a global setting. UK trustees don’t think ‘buy British’ they think ‘just give me good returns’. The investment chain is common to all jurisdictions but you have different flavours in different countries. In the UK it is around stewardship but other countries look at the long term differently, for example Australia looks at climate change.”
Elsewhere on the global theme, it has to be kept in mind that UK companies often have foreign shareholders who in a free market society might wish to have an influence over company policy but might have a shorter term performance horizon and investment outlook than its domestic owners. Therefore, as Hermes’ Nusseibeh questions, is it right that UK investors as a pool of savings own so little of the companies that actually control us?
“That is important because the other big block of owners might happen to be international owners and it [the report] does not square the aspirations of local long-term owners with overseas owners who might be shorter term,” Nusseibeh adds.
Elsewhere, Vanguard chief investment officer, Europe, Jeff Molitor describes the UK as a “slice” of the equity market and not the entire market. “Investors must look globally to get a broader more diversified portfolio. In the UK there are sectors that are overrepresented and those that are underrepresented,” Molitor says.
Linking the chain together
Kay’s review was wide-ranging and touched on other areas which influence the investment chain, such as executive pay, portfolio concentration and whether quarterly reporting fuels a short-term mentality.
However, one of the main issues it raises is this question around how much of UK plc UK investors should own, which is a difficult, political question, particularly at a time when UK pension funds, faced with mounting deficits, are looking more globally for diversification and enhanced returns.
But, while the review could have delved deeper in some areas, such as addressing the role of the asset owner more thoroughly, what comes out of it is a sense that equity markets start and finish with the asset owners themselves and institutional investors such as pension funds and insurance companies need to play their part in the process.
As Aviva Investors’ Skipper believes: “The time is right for pension funds that have done their own governance to move on and influence the investment governance of the markets.”
Comments