Time for fund managers to act
It is time for shareholders to start behaving like the owners of listed companies rather than appearing as hapless bystanders as corporate disasters unfold around them.
In the U.S., the SEC move to allow institutional investors to nominate directors is a small but welcome step in the right direction. To some degree it echoes existing arrangements in Sweden, where shareholders already play a greater role in nominating and approving directors.
But a more fundamental power shift in favor of the owners of publicly quoted companies is urgently needed and the big question is whether institutional investors, chastened by the huge hits they’ve taken as their investments in companies have crumbled, have got the will and the wherewithal to redefine their relationship with the firms they own.
If past performance is any indication of future performance — which thankfully as fund managers’ disclaimers remind us, it is not — the omens are not good.
It is company managers, particularly of failed financial institutions, who have largely and justifiably taken the rap for poor decision making, some shoddy examples of corporate governance, a few cases of unbelievable greed and an underlying short-term outlook.
But where were the investors all this time?
With a few exceptions — most notably “activist” investors like Knight Vinke’s campaign against HSBC’s disastrous investment in U.S. consumer lending unit Household, the attempt by Luqman Arnold’s Olivant to shake up UBS and Legal and General’s call for changes at Royal Bank of Scotland — they were barely seen or heard.
Given that, it is hard to see how institutions have anybody but themselves to blame for ending up the losers.
Both Knight Vinke and Olivant had valid points, although their ideas and modus operandi were scorned by other investors and resisted by the managers whose cages they were rattling.
GET A GRIP
So just why is it that institutional investors have failed to get a grip on the seemingly out-of-control chief executives whose grandiose plans or blind ambition have led to the demise or near collapse of companies?
The simple answer is that long-only funds (those which do not sell stocks “short”) have been historically reluctant to interfere in the running of the companies whose shares they hold, deeming it to be outside their remit. Their line is that they are in for the long term and not there to manage companies.
Indeed, Robert Jenkins, the head of UK fund industry lobby the Investment Management Association (IMA), has argued that funds have been more active than have been given credit for, although at the end of the day it is not up to fund managers but clients to decide how their money should be managed.
Sure, investors should also be keeping their fund managers under close scrutiny. But they expect investment managers to be doing just that, managing their money. And however unpleasant it may be for fund managers, that means getting their hands dirty.
Until now the default position for funds has been the occasional polite letter to senior executives, relatively infrequent meetings and in extreme (and rare) cases voting against the reappointment of executives or the remuneration packages offered.
Whatever the fund management industry may say, the fact is that except for some smaller “active” funds (who like to distinguish their tactics from their more aggressive “activist” brethren and whose field of interest is often smaller companies), useful engagement with companies by institutional shareholders has been the exception rather than the rule.
For this to change the big funds need to take a leaf out of the active investors’ book. If their mandates — such as the index trackers — mean they are not able to vote with their feet and sell their shares then they need to be willing to “go public” and raise issues of concern early if they feel these are being ignored or stonewalled by management.
This is highlighted in the IMA’s own report on engagement. It found that while more investment managers were engaging with companies their concerns were generally ignored. The industry, at least in the UK, is opposed to regulators imposing rules dictating how they should engage with the boards of the companies they own.
But so far at least, it has failed to provide convincing evidence of how it will do it on its own.
As well as using their votes and learning to team up with other shareholders (this is a point regulators need to take on board to ensure that the rules about acting in concert are sufficiently flexible) if their concerns are being brushed aside, institutional shareholders need to think whether they have got the right mix of experience among their managers.
Active and activist managers say their advantage is they often have real business experience, arguing that this is something lacking among managers in the wider industry.
Funds that focus on corporate governance also point to the resource they devote to covering a company. They tend to dedicate their fire on a handful of companies with a single issue. They argue that the ratios within the large fund management companies are never going to be significant enough for the managers to devote sufficient time to active engagement.
The good news is that the fund management industry has woken up to the failings of the past. The bad news is that the major shake-up of attitudes required to change the way funds operate and for them to openly challenge company management is likely to be too late for many of their investments.
— At the time of publication Alexander Smith did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. —