All talk, no action?
Written by Laura Blows
January/February 2012
Laura Blows explores whether the increased calls for shareholders to keep their companies in check has resulted in pension funds becoming more engaged investors
There has been much noise made about the role of shareholder activism lately. Ever since the onset of the financial crisis, in fact, fingers have been pointed at the behaviour of company boards and shareholders’ ability to rein them in.
Putting the shareholders under scrutiny certainly isn’t unreasonable. Cevian Capital senior partner Harlan Zimmerman says: “In the UK, and other markets where there has been a problem with companies, we should ultimately blame the shareholders as they put the directors in place. In the UK there had been a lot of rubber stamping of company decisions occurring with shareholders, so they were not being so responsible.”
Regulations have recently emerged to modify such shareholder behaviour. One such example is the UK Stewardship Code, created in summer 2010 to improve the quality of shareholder engagement with companies to encourage long-term returns and corporate governance.
Also in the UK, economist Professor John Kay has just finished the consultation process for his review, commissioned by Business Secretary Vince Cable, of UK equity markets to prevent short-termism from investors and promote a more long-term culture from UK business.
Despite these efforts, not everyone is convinced that they will lead to responsible capitalism. UK MP Jon Cruddas recently argued that: “Making companies more accountable to shareholders will not be enough to tackle ‘crony capitalism’: shareholders themselves must also become more accountable to the ordinary savers whose capital they invest.” UK Minister for Pensions Steve Webb responded to this by saying that trustees’ fiduciary duties are frequently misunderstood to mean maximising short term returns at all costs.
This spotlight on ‘short-termism’ began from people looking for causes to the financial crisis that began in 2008. One area of concern that emerged was the short-term mentality of shareholders. Even within shareholder activism, generally considered to be working towards the ‘greater good’ of a company, there are ‘corporate raiders’ who attempt to make changes to a company just to capitalise on short-term value increases.
Kas Bank managing director Lauren Vis explains: “The market had become very short-term focused, with average holdings dropping from eight years to under a year. However, the market is moving away from short termism, which is good news. In the pension industry there is an interest with improving companies for the long term. This long-term shareholder attitude creates long term business, which is both good for the economy and generates a better return for investment.”
He adds that some responses from the UK’s Kay review even go so far as to suggest a two-tier share system, with a long-term share class providing a better dividend than short term shares, such is the support for long term investment.
So why is short-termism seen as the antithesis of responsible investment and long-term investment the saviour?
According to Vis, the relatively recent financial turmoil has shown that well-run businesses looking long term have much to offer. “The goodwill of these organisations working in a prudent direction for the interests of the shareholders is in for a comeback. Most markets were hit by the financial crisis so it revealed that short term investment may not have been such a good idea.”
Along with long-term investment, the increased transparency of ownership is also on the list for improvement. The European Commission is looking to update its Transparency Directive, which would prevent investors from secretly building up a controlling stake in a listed company (hidden ownership). It claims that such practices can give rise to possible market abuse, low levels of investor confidence and misalignment of investor intentions.
The length of the investment and shareholder transparency has been under scrutiny, but another focus is shareholders’ level of engagement. Zimmerman explains: “Without a doubt the average pension fund has paid much more attention to engaged activism following the financial crisis. Whether that’s in terms of awarding mandates to people directly managing their own assets, working with the companies they invest in directly, or in some cases engaging with activist investors.”
But just how active an investor pension funds are can vary by country. For Vis, mainland Europe is more associated with active shareholders.
He cites continental Europe as having a more ‘balanced approach’ between shareholders and the board, with increased dialogue between the major shareholders.
In contrast he warns that the UK’s attempts at shareholder activism may be considered as ‘strangleholding’ the board.
Within Europe, the pension funds of the Nordic region are highlighted as particularly engaged. Sweden especially is heralded for promoting excellent investor engagement.
Zimmerman says: “Swedish pension funds are probably the most engaged, due to their involvement with the nomination committees that select the board directors, instead of just approving the board-suggested candidates. This makes the board more likely to work for the shareholders and makes the shareholders more focused on what the company is doing.”
This system developed, Zimmerman explains, as many companies in Sweden were controlled by big family groups, so this structure was factored in to counter their influence.
According to Zimmerman, Norway has a similar system, while companies in Finland individually decide whether to adopt this system. The nomination committees in these countries meet four to five times a year, he adds, to decide on what the company is doing, therefore creating collective engagement.
However, European pension funds that are involved with their invested companies themselves are few and far between. Understandably, it is only those large schemes with a high enough level of resources, such as the UK’s Universities Superannuation Scheme (USS) and RailPen that are able to directly get involved.
Even these large schemes have to work together to try and make a difference with their engagement policies. For example, RailPen has pooled its governance expertise and resources with USS to establish a voting and engagement alliance in the UK.
Both these schemes have joined the recently established Stewardship Working Group, also comprising of Tomorrow’s Company and leading activist investors Aviva Investors, BlackRock, Governance for Owners and Ram Trust.
It aims to identify engagement styles and practices that seem to be most effective, through interviews with board members of leading UK companies to provide companies’ feedback on stewardship and their criteria for good stewardship. The project team will be examining how companies judge the quality of stewardship, sources of frustration for companies and what they would like to see change.
However, for the average pension scheme without the in-house resources to focus on responsible investment, recruiting specialist activist investment managers can be a practical way to become engaged.
One such company is PGGM, a Dutch pension administrator and investment management organisation that supports five pension funds in the Netherlands, with €109 billion of assets under management.
PGGM managing director for responsible investment Marcel Jeucken explains its approach to responsible investment: “PGGM represents its clients as an active shareholder, because we believe it is the responsibility of shareholders and large financial institutions to address companies and markets about their policy and activities.
“We and our clients engage to bring about improvements in environmental, social and corporate governance matters. Our belief is that this will ultimately contribute to a better social and/or financial return on the investments. We engage with companies on all material ESG issues and particularly on four main themes: human rights, climate change, corporate governance and health. We also vote on the basis of our own judgement at shareholders’ meetings. In this way we contribute to good corporate governance. We also devote particular attention to resolutions in the environmental and social fields.”
ESG factors have remained high on engaged pension funds’ agendas, along with voting on board structures, and since the financial crisis, the remuneration policies of companies have climbed higher up the list of priorities for shareholders to address.
However, there has been a tradition in Europe, especially the UK, of voting with your feet, by simply not investing in a company you are unhappy with. Being an activist investor and working to improve a company has played ‘second fiddle’ to investment performance, Zimmerman explains.
It is not necessarily a lack of willingness that prevents pension funds from being responsible investors though. Trustees rightly consider corporate governance a trustee issue, but lack of time and resources can result in this becoming a box-ticking exercise, or simply putting more pressing concerns, such as fund deficits, above the idea of engaging with companies. Instead, they rely on fund managers examining the corporate structure of their investment, which is not the main priority for fund managers chasing a return on investment.
Governance for Owners partner Simon Wong says: “Many pension funds are still struggling with the recurrent theme that they are too small to make a difference engaging with companies. Also, the general trend of pension funds moving away from equities and diversifying outside of domestic markets makes it harder for pension funds to be willing or able to engage with companies.
“Another challenge for pension funds is that key decisions are left to outsiders. They need to be able to ask the right kind of questions to their fund managers instead of relying on their investment managers somewhat blindly.”
He says that despite the emergence of the UK Stewardship Code around 18 months ago, companies have said that they have not noticed any discernible increase in the engagement of investors.
It’s not all doom and gloom though; he adds that several larger investment houses have recently found a greater interest from their portfolio managers on corporate governance.
Vis has also noticed that pension funds are much more vocal and wary about which companies to invest in and which not. “Even when they invest in pools, investment trusts, they have their requirements. So the issuing companies will become more transparent about their code of conduct and their own compliance becomes part of the investment decision,” he explains.
Despite the many discussions, regulations and general concerns about shareholders not keeping companies in check, the reality is that it is still only those very few schemes with significant resources that are able to really take action. A consolidated approach has helped though, be it through pension funds teaming up, joining lobbying groups or using activist investment houses to increase engagement. But even with the best of intentions, for the time being pension funds with limited time and resources, and one step removed from the companies they invest in through the use of fund managers, will struggle to increase their shareholder activism to levels many wish they could achieve.
