Responding to the Myners’ strike

June 10, 2009 by · Leave a Comment
Filed under: The RSA 

Thanks to Duncan, Steve, Michael and Colin for their advice ahead of my gig last night at the Corporate Governance Circle. I was responding to a forthright speech to the always engaging and direct Lord Myners (who, gratifyingly, had also read the post and comments). I knew less about the subject – ‘Institutional Investors – are they the weakest link’ – than anyone else in the room but I think I just about got away with it.

My key point was to link the debate about corporate governance and stewardship to the emergence in 2012 of Personal Accounts. If these succeed – and the RSA has proposals which we think would help to ensure they do – they will create a huge source of regulated funds with the scope to impact directly on how British business is managed and indirectly on the behaviours of other institutional investors.

Although he expressed it in the most positive of terms, Lord Myners’ basic point was dispiriting for those seeking to improve the quality of corporate governance. He told the assembled investors that they already had the power to influence the companies in which they are invested. In typically robust style, he suggested that if company annual general meetings didn’t exist, someone would now be calling for them as the solution to all our problems: ’Hey, why don’t we have meeting every year where the whole board has to attend and at which shareholders can ask any question they want and table resolutions over key aspects of governance?’ ‘You have the power’ said the Lord ‘but the reality is that you choose not to use it’.

I had gone into the meeting thinking the big difficulty in this policy area was the principal – agent problem but I came to see that it is actually a collective action issue. The diffusion of ownership in almost all large funds – driven by modern portfolio theory – means that typically no fund owns more than one or two percent of a company. Why then should they be the ones to take on the onerous and risky business of holding companies to account? Interestingly, no one in the room denied Lord Myners description of the problem or offered a solution.

This morning David Pitt-Watson (who leads on our Tomorrow’s Investor project) and I met with Tory Work and Pensions spokesperson Theresa May to discuss our project and hear her views on personal accounts. She said some very interesting things to which I will return in a later post. But on the way back to John Adam Street I quizzed David on the issues of investor influence. The RSA proposal is for a low cost pension fund delivered through personal accounts but we also claim this fund could have a benign impact on corporate governance and stewardship, helping for example , deliver George Osborne’s vision (elucidated in a speech yesterday) of a more long term investment culture. ‘But how can we be both cheap and influential?’ I asked.

David assures me he has an answer and that it is in the forthcoming Tomorrow’s Investor report. I am looking forward to reading it

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Institutional investors – help, please

June 9, 2009 by · 7 Comments
Filed under: Credit crunch, Politics, The RSA 

It is a welcome relief to post about matters other than the Labour Party. And today I am asking for help. Tonight I have to respond to Lord Myners after he has spoken on the topic ‘Institutional Investors – The Weakest Link’.

As I will be, by far, the person in the room with the least knowledge of the subject I thought I would share some initial thoughts and implore my readers to help me turn them into something coherent. It should be easier for me as I can predict what the minister will say as he spoke on a similar topic a few weeks ago. The key quotes from that speech, as reported on the excellent Labour and Capital blog were:

Institutional investors are expected to exert the influence and exhibit the values of “owners” but are incentivised to behave as “investors”, with performance scrutinised on a quarterly, monthly or even a daily basis.

In this context, we have almost certainly understated the profound challenges faced by the majority of institutional fund managers in fulfilling expectations in respect of the broader definitions of governance where they relate to ownership (here I exclude those fund managers who place governance at the core of their commercial offering).

To put it simply: most institutions are not set up to act as owners; they don’t have the mindset of owners and are not incentivised by their clients to act as owners. They are investors- leaseholders rather than freeholders.

And:

Short termism, as practised by pension funds, is self-defeating for those charged with delivering pensions over many decades in to the future, and yet it remains a predominant form of behaviour.

A focus on “shareholder value”, as measured by relative share price performance over quite short time periods lies at the heart of a number of behaviours which have delivered less than ideal outcomes, such as:

the ascendancy of momentum investing which discourages contrarian thinking by all but a small minority;

a partiality to merger & acquisition activity which so often fails to deliver the outcomes promised;

the adoption of aggressive and inappropriate capital structures to fend off predatory activity by private equity and others; and

a failure to take account of the longer-term consequences of investment activity, including impact on the broader economy and society.

The problem is that this is exactly the argument I would have made, but much less elegantly.

The only thought I have right now is to suggest that Lord Myners’ arguments, plus the poor average performance and exorbitant costs of actively managed funds (see our Tomorrow’s Investor report),  throw into doubt the whole question of Joe Public gambling their savings and pensions in the stock market. Just as representative democracy is a blunt tool (see post last week), so ordinary small investors have neither the expertise nor the clout to have any influence.

This leads me to go back to some very basic points:

1) Population ageing and our addiction to debt mean that we need more people to save more. To encourage this people need to feel that they are getting reliable returns.  

2) Overall, it is probably better for the British economy for people to save by investing in the market rather than in housing, gold or fine wines?

3) But there is no reliable way to decide how best to invest our billions in the market. As I said before, actively managed funds have actually done worse that indexed funds over the last ten years.  We can – and should – add good governance to shareholder value but let’s remember that two years ago RBS, HBOS etc would probably have argued that they were exemplars of good governance and corporate responsibility.

There is a lot of talk of greater transparency but as many people have pointed out – including John Lanchester in a brilliant polemic in the LRB  – the information about the banks’ dodgy investments in CDOs and sub-prime loans was in their annual reports, albeit opaque to any but the most diligent expert. The problem was that only a few voices in the wilderness were shouting about the risks involved in these investments. And, as we now know from Robert Shiller and others, these warning voices are rarely heard in a bull market.       

4) For most of us – and this may be where I start getting things wrong – a long term rate of return in line with the average growth of the economy (inflation plus 1.5-2%) would be fine. This would be enough to make it worthwhile for people on near or above average earnings to save for a decent pension (as long as they started early and kept up with the payments).

5) So, if we were designing a system from scratch and – this is crucial – we were oblivious to the self interested arguments of the financial services sector what would we build? Would we end up with what we’ve got and simply have to reconcile ourselves to the occasional crash followed by ritual stable door shutting, or would we design a radically different system?

6) If the new framework for pensions is introduced in 2012 (and this is becoming a bigger ‘if’ by the day, I sense) there may an opportunity to use the huge resources that will be administered by the Pensions Authority to reconstruct the architecture of savings and investment but there are big question marks hanging over the viability of the new framework, let alone what its investment strategy should be.

So I guess my big question is this: Don’t we need to bring the debate about pension reform (one that the major parties seem to me to be dodging at present) together with the debate about regulatory reform?     

I know this is a hopelessly ill-informed ramble so I look forward to getting advice from all of you who know a great deal more……

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