Looking after your investment

Pensions Age May 2005

All variety of demands on pensions trustees have increased in recent years, and not least has been the requirement for them to take a more active role in using their shareholder votes. Indeed, there have even been calls for institutional voting to be made compulsory.

But that’s not as easy as it sounds, especially if trustees must also prove that they have exercised their votes wisely. That can be difficult, and a considerable amount of information may be required to assess if the ‘right action’ was taken. Suppose, for example, a chief executive of a company in which a pension fund is invested is paid £1.2 million – is that too much?

To make that determination, one must look at, among other things, the going rate for similarly sized companies, other companies in the same sector, how that pay compares to the company’s performance and so on. A fund might have twenty or thirty such holdings, and the trustees would need to make these decisions on all of them.

It’s not surprising then that Anita Skipper, head of corporate governance at Morley Fund Managers, says: “Not that much has happened yet on meeting the activism requirements [of the Myners report].”

Charities, trade unions, and church funds have led in social responsibility issues, but corporate governance is still seen by many funds as a nuisance rather than an integral part of the job. Rory Sullivan, director of investor responsibility at Insight, says that while some schemes and funds lead the way, “those who just don’t do anything at all are still in the majority”.


One reason for this is expense, and an idea of the costs involved can be assessed by looking at the size of teams employed by the more active fund managers and research firms. Insight has a team of eight working on corporate governance issues – “which most pension funds couldn't afford” according to Sullivan – while research firm Manifest has 25 analysts and RREV a team of 10. To have anywhere near those numbers would severely stretch the resources of most small schemes or fund managers.

There are, however, an increasing number of corporate governance tools available for both trustees and investment managers. For instance, there are now FTSE CGI indices which give fund managers a method for assessing corporate governance risks across countries and sectors, which allow fund managers to eliminate those companies which have the highest corporate governance risk – though, of course, if they do so, they will have turned their back on any possibility of constructive engagement with those companies.

There are also an increasing number of research services which give advice on corporate governance issues. RREV, in which the National Association of Pension Funds is a shareholder, gives voting recommendations and also provides a web-based voting service.

Manifest, on the other hand, prefers to concentrate on researching and explaining the issues, refraining from providing voting recommendations. PIRC researches both corporate governance and social responsibility issues, and is able to help clients develop integrated proxy voting policies.

At the more extreme end, Deminor, based in Brussels, provides research on most of the larger European stocks, but has also led a number of class actions on behalf of shareholders – a rather different emphasis from the UK houses.

Aside from pure research, there are other business models available as well. For instance, fund manager Insight has recently taken over responsibility for Wellcome Trust’s corporate governance activity. As a fund manager, Insight believes it has more leverage with companies than the research firms. “We do engagement and voting and it is linked to our decision making,” says Sullivan.

But the interesting thing about the relationship with Wellcome is that Insight doesn’t actually manage any of the funds involved – it simply manages corporate governance issues on Wellcome’s behalf, while separate investment managers run the funds.


Further costs

Besides the cost of researching corporate governance issues, which can be considerable, there is also a high administration cost attached to the actual mechanics of voting. Tim Sawyer of RREV calls the AGM season “a painful, messy time”, as trustees and fund managers have to research the corporate governance issues behind AGM votes to tight timescales, with a very high concentration of votes coming just between April to June.

It is perhaps not surprising then that when Paul Myners recently assessed progress since his original report, the difficulty of paper-based voting was seen as a major impediment to the process.

While 88 per cent of FTSE 100 companies now have electronic voting – up from 47 per cent in 2003 – only 41 per cent of the FTSE 250 have, and only five of the 195 investment companies reporting in H2 2004.

This can be offset, however, by firms such as RREV which now offer complete voting systems. Sawyer sees more and more RREV customers taking up the web-based, e-voting system on offer, though he can't say what proportion of the market as a whole they represent.

He believes that voting is a natural area to outsource. “Setting up the processes, complexity, and checking are all expensive,” he says. “So if you’re a relatively small outfit it makes sense to outsource it.”

And, although the corporate governance debate is largely focused on voting, that isn't the be all and end all. Morley’s Skipper adamantly says: “We do corporate governance all the time – it’s not just voting.” Active fund managers will often have a chance to raise issues informally with company directors over the year, and while the AGM vote may crystallise decisions, engagement outside the AGM season can be more important in achieving corporate governance objectives. Sullivan points out: “Voting is just too blunt an instrument [to rely on].”


Making the most of it

Not only is there a wide range of corporate governance tools, but there is also a choice for trustees of how to use them. For instance, a larger scheme could decide to purchase corporate governance research and keep this responsibility in-house, though the costs are still likely to be high compared to an outsourced solution.

Some trustees are now incorporating reference to a particular research service or to particular principles, such as the NAPF guidelines, into their fund managers’ mandates.

Sawyer says: “The obvious solution is to use someone like RREV and say to the fund manager, ‘we know what’s going on where you diverge from the NAPF rules’ or ‘this is our policy and please implement it’.”

He says about 60 per cent of RREV’s customers are fund managers and only 30 per cent are trustees, so it’s obvious that many trustees expect their fund manager to look after the issue for them.

However, Sarah Wilson, managing director of Manifest, warns that trustees should not adopt such a solution lightly. She believes that specifying a research product or methodology is a way of avoiding having to think through the broader corporate governance principles.

“Buying policies off the shelf is not what it’s about,” she says. She also believes that using this approach can stack up fund managers’ costs; if the fund manager is using a research company that is different from the client’s, that adds a layer of cost and complexity. And, Wilson adds: “The fund manager is not in a position to manage 35 different flavours of corporate governance.”

Sullivan, too, believes that trustees need to work on understanding what the corporate governance principles in the statement of investment principles (SIP) mean in practice: “How do top level principles translate into voting?” He points out that working through these issues with the Wellcome Trust took quite some time. “You need a framework for engaging with companies,” he says.

And it’s becoming clear that that framework should include a link between corporate governance and investment. Skipper lays out Morley’s beliefs: “It’s very important that corporate governance and investment management are linked together, as at the end of the day, there’s only one aim – to increase the value of your holdings in the company.”

That may mean that the responsibility for corporate governance should remain with the fund manager – using research services on corporate governance to arrive at decisions, but doing so on the basis of a holistic approach.

Where things have certainly changed is that even if not everyone is doing corporate governance ‘right’, it has become a central issue for investors. Wilson believes that “We’ve moved on. Corporate governance isn't the Cinderella it once was; it’s mainstream. We’ve had lots of rhetoric, now we have to work out how to execute.”

 

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