06 February 2020 by Anthony Hilton
A new paper discusses how stewardship could be improved over the next ten years
It is 15 years since Hermes, the fund manager which grew out of the Post Office Pension Fund, launched its stewardship service for institutional investors. To mark the occasion it has launched a paper, Stewardship: The 2020 Vision, which gives its view about what needs to be done, if stewardship is to become more effective over the next decade.
Saker Nusseibeh, the CEO, says that the world faces multiple challenges from artificial intelligence to climate change, and needs to address these problems not compound them. Focussing on wealth creation at the expense of the planet and society is counter-productive, he says. The investment management industry could be a potent force in building a better world but today that potential is largely unfulfilled.
The purpose of the report is not to indulge in box ticking, though that is what companies and the regulator, the Financial Reporting Council, tend to do. Indeed an independent review of the FRC said: “The regulation of stewardship focuses on checking the content of stewardship statements not on actual outcomes”. It added that if it just continued with boilerplate reporting “that serious consideration should be given to its abolition”. Quite an indictment!
Among the challenges, stewardship is largely confined to large companies and is crisis driven rather than proactive. There is too much focus on executive remuneration at the expense of strategy and risk management. It tends to follow on from financial updates and its representatives are too focussed on information seeking rather than change seeking.
This paper takes a different view, which academic evidence supports saying that higher returns of 7.1% per annum have been achieved by active ownership. It says that these investment returns come from the business being well managed and responsibly governed. This means it promotes diversity, supports communities, and creates opportunities. It improves the lives of employees, safeguards the environment and pays taxes.
The paper argues that the industry has been too short term in its focus and has neglected its role as provider of long term supportive capital. This has led in turn to a lack of real progress in environmental, social and governance (ESG) issues.
Stewardship needs to be a determining factor in investment decision making, product development, client relationship management and reporting. This means boards of companies must continue to be accountable to investors but that relationship needs to evolve to be more collaborative.
For stewardship to be taking seriously it needs to be embedded in the way a firm carries out its business to become a core part of its strategy. Relying on the market to achieve these outcomes is naive, instead it means a step change in investment and portfolio management.
Currently stewardship accounts for only a small proportion of the resources available to investment management firms. This needs to change so that they will be at the heart of the investment industry. In this role they will focus not just on equities, but also on corporate credit, infrastructure, private equity, real estate, sovereign debt and hedge funds – all the asset classes in fact.
Even then the stewards cannot possibly know every company intimately. That means they should also when necessary band together with other investment firms to cooperate in dealing with difficult situations – though they do not always like each other so it may be difficult.
The potential for stewardship to transform financial, social and environmental outcomes will not be realised if it does not change. But the engagement also needs upgrading. Instead of latching on to remuneration it must become much more outcome oriented – asking for a director to be appointed with specific skills, or setting specific performance targets and so on. These will then have to be externally verifiable to make sure that if companies do commit, then they will also be held to account.
Another thing is for the investment managers to engage at the correct level. Too often they are fobbed of with a junior employee and even if he or she is enthused, the points do not make an impact at board level. Given that the investment management side will seek to recruit across the sciences, accounting, law, human resources, strategy consulting and so on, it is only reasonable that companies engage with persons who can influence decisions. This is certainly what the research shows too – engagement has much more impact on performance if the boards of companies do what is asked of them.
Of course investment managers themselves need to walk the walk, to ensure that their own governance and incentive schemes align with the parameters imposed on companies. This not the case at present – particularly with remuneration.
So what is the eventual outcome? Well at the moment the paper sees companies chopping down apple trees to harvest the wood. By 2030 they hope companies will instead have planted more trees, got sweeter tasting apples, and created better jobs by investing in enhanced growing and harvesting techniques.