INVESTORS’ RESPONSIBILITY

Fiduciary challenge

JOHN PLENDER, senior editorial writer and columnist on the Financial Times, discusses where the UK debate on ‘responsible’ share ownership is likely to go. The globallyrelevant
arguments will resonate with SA pension funds and their asset managers.

Responsible ownership in equity investment is now not only a familiar concept but politically correct. Who, after all, could claim to be in favour of irresponsible ownership? Yet despite the arrival of the UK’s Stewardship Code, which is increasingly being imitated in continental Europe, there are many areas of the markets where behaviour
remains pretty unreconstructed.

First, consider the issue of investment performance. Despite the strictures of Paul (now Lord) Myners in his report to the UK Treasury back in 2001, many pension fund trustees and other representatives of end investors still persist in judging fund managers’ performance relative to peers over short-term horizons.

For their part, many fund managers seek to minimise their own business risks by hugging
benchmarks. This leads to herding, which makes for a poor allocation of capital in the real economy. The costs of this behaviour have been well highlighted by Paul Woolley and others at the London School of Economics’ very aptly named Centre for the Study of Capital Market Dysfunctionality.

The problem is compounded because many trustees, consultants and fund managers follow
a narrowly financial definition of investment performance. Despite the damage to BP following the
Gulf of Mexico disaster, among other disasters, they continue to see any focus on environmental concerns as a potential breach of fiduciary duty rather than part of their duty to manage risk prudently.

While the UK Stewardship Code offers a constructive way forward on shareholder engagement,
it has to be said that the quality of the statements submitted to the Financial Reporting Council, the code’s sponsor, are very mixed on such issues as conflicts of interest. These conflicts are one of the main factors that inhibit fund managers from addressing corporate underperformance.

If we look at the retail market, it is striking across much of Europe that through a period of
deregulation this is one of the few areas of finance where charges remain stubbornly high or have even gone up.

Today’s Trustee June/August 2011 41 Plender.indd 2 6/3/11 12:44:00 PM In effect, a disproportionate chunk of the gains from investment activity go to intermediaries rather
than end investors. That scarcely seems compatible with putting the interests of the client first. Here, as in much of the wider banking area, only lip service is paid to the fiduciary concept.

In the wholesale area these shortcomings are primarily the fault of owners. Fund managers are
simply responding rationally to a set of flawed incentives that their clients have given them.
I would not wish to downplay the importance of the Stewardship Code in addressing these issues. Yet it seems reasonable to ask whether the ownership function needs to be buttressed by other means. And there are people around who are beginning to do precisely that.

Tomorrow’s Company, the London-based think tank, recently called for a review of the fiduciary
duty of pension fund trustees and other investors along the lines of the UK Company Law Review. It wants stewardship to be an explicit part of fiduciary duty and at the heart of investment performance. Mark Goyder, founding director, says the investment world needs to reconnect with the idea that the best interest of the clients lies in promoting healthy companies that inspire
talented people to create excellent goods and services that people want.

Now FairPensions, a group that campaigns for responsible investment, is to publish a report which argues that prevailing interpretations of fiduciary obligation have lost their way, neglecting the core duty of loyalty, including the duty to avoid conflicts of interest, in favour of a narrow focus on maximising returns.

It, too, would like to see a review of the fiduciary obligations of investors, including those of asset managers and consultants. FairPensions argues - as does Tomorrow’s Company - that the millions whose pension savings are based on contracts with insurance companies where no trustees are involved need to be included in this debate.

It also feels there is a need for legal clarification of the extent to which pension funds can take nonfinancial factors into account for their own sake, to resolve a decades-old debate on ethical investment. And it would like to introduce an equivalent of the enlightened shareholder value concept that underpins directors’ duties in UK company law into the investment arena.

None of this will appeal to those fund managers who fought a long and dogged rearguard action against Lord Myners’ reform agenda and the Stewardship Code. Yet the environment in which investors now operate has changed greatly since the original Myners report in ways that challenge the industry’s accepted wisdom.

These calls for a re-examination of fiduciary duty will be resisted. But I suspect they will, in time, find growing support.