3rd September 2010
A significant aftermath of the credit crunch for fund managers has been the expectation by their clients and regulators that they will be more careful stewards of their shareholdings.
The results of the second annual survey by Penrose Financial on the future of the pensions & investment industry show that two-thirds of fund managers believe that client pressure will compel fund managers to increase their level of shareholder engagement.
Certainly fund managers are facing pressure from all sides. The findings of the Penrose report follow hot on the heels of the recent publication of the Financial Reporting Council's UK Stewardship Code (opens in PDF format), which urged large shareholders to monitor companies actively and seek corporate change when necessary. Its guidance is mercifully concise.
This analysis by the Financial Times charts the progress of all the global regulatory initiatives to improve shareholder engagement.
Clearly, many regulators would like to compel shareholders to be more active managers of their shareholdings, engage with companies to improve corporate and risk management.
Equally, this thread on the Motley Fool bemoans the weakness of large shareholders in challenging corporate management. In this case, it is company-specific, but it demonstrates the increasing frustration on the part of their clients and smaller shareholders.
In practice, most fund management groups are well aware of the need to monitor their shareholdings actively. It makes sense from a financial and moral point of view.
They recognise that many of their clients are being monitored for their ethical behaviour – as this report from Fair Pensions shows (opens in PDF format) – and they need to respond to this expectation. There is a recognition that there has been a failure of governance by shareholders in some cases.
And most have responded with conviction, as this report from IPE demonstrates Almost all now have a shareholder engagement policy and the majority are active in voting.
As one fund manager points out in the most recent IMA survey (opens in PDF format) of the investment industry: "In the credit crisis, there were problems that the senior managers missed, the board of directors missed and the regulators missed, all of whom had access to privileged information that institutional investors did not.
"So what do they think that institutional investors should have come up with?"
Shareholders may appoint corporate management, but they are not company management themselves and cannot be expected to run the companies in which they invest.
Equally, they can perform due diligence on companies to build an understanding of the potential risks, but they cannot manage those risks for the company. They are not experts in oil exploration, or retail management.
There are also some investment strategies that are largely incompatible with full shareholder engagement. Passive and quantitative strategies are obvious examples, but recovery or trading strategies are also difficult to square with full shareholder engagement. Recovery strategies tend to invest in companies that have seen significant problems.
Trading strategies are only interested in short-term ownership.
Lord Myners, a City minister in the previous Labour government and a critic of the ‘ownerless corporation', has been quoted in the Financial Times, saying that the new code is flawed because it has failed to drive clarity around where responsibility for governance lies, whether with trustees or beneficiaries.
He concludes that it should be with the ultimate investor.
This is true to some extent, but shareholders cannot take the place of responsible corporate management. It is merely their duty to ensure that that management is in place.