According to John Kay, author of a 2012 government-sponsored review of the UK equity market, there was too much trading and not enough trust in the financial system.
“The inclination of asset holders to judge asset managers by reference to short-term benchmarks led managers to focus on meeting those benchmarks,” he says.
“The financial crisis illustrated the weakness of the system,” says Jane Goodland, senior investment consultant at Towers Watson. “Shareholders have a role to play in holding company boards to account and that was not really happening. The balance of power was wrong.”
One of the concrete responses to this was the UK Stewardship Code, which was introduced in 2010 to improve engagement between asset managers and the companies they invest in, in the hope that this would encourage a longer-term focus and therefore boost long-term returns for shareholders and their beneficiaries.
It was revised in 2012 “to clarify the aim and definition of stewardship” in the wake of the Kay Review, which recommended that it incorporate “a more expansive form of stewardship, focusing on strategic issues as well as questions of corporate governance”.
So what effect is it having, if any, on investment markets and practice?
Asset managers have to disclose whether they have signed up to the Code and if not, explain what they are doing instead. “Because investment managers are required to make that disclosure, they have thought a bit more about how to adhere to the Code, even if for many it is simply a formalisation of what they were doing before,” says Goodland.
The Code has made pension funds “consider to what extent they want to take an active position or not,” she adds. And it has changed behaviour. “The very act of asset owners and managers taking a moment to reflect about where they sit in the market has had an impact. Very large investors, in particular, are doing much more than they were.”
The Code is “an important first step”, according to Steve Waygood, chief responsible investment officer at Aviva. “But, I am not convinced it goes far enough. Many, many more steps need to be taken.”
One area in particular that needs to be looked at is the role of consultants, he says. “In many markets, particularly the UK, they are very powerful. We need to explore the role of investment consultants and see if they have a duty of care on stewardship.”
Some consultants are doing very good work in this area, he stresses, citing Mercer, Towers Watson and Russell as examples. The Financial Reporting Council, the UK body that was the principal architect of the Code, points out that “consultants, while important, are not part of the investment chain”, and that the “real responsibility for good stewardship is with owners”. However, Rob Pomroy, policy lead for corporate governance and stewardship at the National Association of Pension Funds (NAPF), backs Waygood’s assertion.
“Many consultants have signed up to the letter of the Code, but adherence to the spirit of it seems to be diminishing,” he warns. “They are not raising [the Code] with pension funds as much as we would like them to.”
While this is less of a problem for larger funds, smaller funds operate under resource constraints and rely much more on the advice of consultants, he adds.
Owners are taking that responsibility on board, asserts Pomroy. “We are increasingly seeing pension funds incorporate the requirements of the Code into investment mandates and the quality of engagement is improving. It is leading to a virtuous circle where pension funds are driving the market.”
The Code is “slowly getting there”, agrees Will Oulton, global head of responsible investment at First State Investments, although the amount of explicit support from the UK pension fund industry “is a bit lacking”. However, he adds that First State has “seen a definite increase in questions from our clients about our response to the Code”.
First State sees itself as a steward of its clients’ money and sees stewardship as “central to our business”, in Oulton’s words (see box). Even so, First State has not become a signatory to the Stewardship Code, which applies only in the UK. As a global investor, “it does not make sense for us to focus on a specific Code,” Oulton says. “We don’t have a different view once we leave the country. There are similar codes in development in Australia, Japan, Malaysia and Singapore.” There are also schemes in place in South Africa, Switzerland and Italy, while India is consulting on its own initiative.
“It makes more sense for us to develop a set of global stewardship principles that we believe will be compliant with all of these emerging codes,” Oulton concludes.
Despite the Code, there remains a “cultural blindspot” within the investment community on issues such as governance, ethics and sustainability, Waygood adds. “Many more research commissions must be directed towards long-term buy-and-hold analysis and brokers should be required to offer a view of these issues when they issue a buy note,” he suggests. “If they had to do this, analysts would be more inclined to offer an opinion that is genuine because companies would not be able to choose between brokers based on their silences.”
Asset owners should be prepared to put the stewardship statements of asset managers to the test and hold them to account, Waygood says. Aviva has called for an investment industry stewardship AGM that would enable the asset-owning clients of asset managers to hold their clients to account. “That starts to extend the chain of accountability beyond companies to investor representatives and asset managers and it helps to engage asset owners.”
Waygood has his doubts, though, about whether the Code will banish the short-term mentality that permeates the asset management sector and which Kay criticised in his review.
Despite politicians having instigated a number of reviews that have raised all sorts of fears about the investment process – before Kay, there was Myners, Hampel and others – “the short-termism of the electoral system and the short-termism of the market are not correcting each other”.
“Ultimately, I would like the Code to become something that asset owners oversee, with much greater delineation between owners and asset managers so the owners hold managers to account rather than having them just signing up to some statement,” Waygood says.
However, Kay is optimistic, if cautiously so. “We are talking about making long-term cultural changes so it is difficult to assess progress so far,” he tells IPE. “But, the reaction I have had from most asset managers is that this is what they would like to be doing.”