Should fund managers be getting tougher with companies they invest in?

investors-voting-at-annual-general-meeting

A raft of shareholder revolts at some of the UK's best-known companies suggests that fund managers are getting tougher with the companies they invest in.

So far this year, shareholders in BP, Smith & Nephew and Paysafe have voted against proposed remuneration schemes. Elsewhere, WPP and Royal Dutch Shell were able to push through pay packages for their chief executives - but faced resistance in the process.

Beyond executive pay, asset managers have also taken companies to task about the effectiveness and make-up of their boards, auditor choice, corporate tax transparency, succession planning and climate change.

They are seeking to influence the corporate governance of the companies they buy into. And many take the view that doing so can result in better returns for investors, as well as bringing about positive change for society.

LONG-TERM INCENTIVE

'From our point of view, asset managers have a huge amount of positive potential to be a force for good.

'This means not just being a source of returns but also stewarding companies so they have a positive impact on the environment and society,' explains Jonathan Hoare, director of policy at ShareAction, a charity promoting responsible investment.

Whether asset managers take an 'active' approach through stock selection or one that is 'passive', seeking exposure to the market through exchange traded funds or index funds, Hoare believes that asset managers have a duty to influence companies to act in the best way possible.

So are asset managers doing enough to engage with the companies to which they are exposed in? Neville White, who heads up asset manager EdenTree's socially responsible investment (SRI) policy, is not convinced - particularly on the issue of executive pay.

'There is clearly a problem in the FTSE 100. We opposed 80 to 85 per cent of FTSE 100 remuneration reports, simply because the multiples on offer were wholly excessive,' White says.

He cites long-term incentive plans that provide executives and chief executives with the potential to earn between 600 and 900 per cent of their already sizeable salaries as examples.

Last year, EdenTree voted against or abstained from voting at around 9 per cent of resolutions at company annual general meetings (AGMs), which White says compares to a market average of 3 to 4 per cent.

To put this into context, it is important to remember that the majority of resolutions proposed at AGMs are routine and are typically non-contentious.

GOVERNANCE IS CORE

Corporate governance, which refers to how well companies are run and managed on behalf of shareholders, represents one of the factors that EdenTree's fund managers consider before investing.

'It is one area that really binds investment managers into a business,' White adds. In his view, professional investors who do not view corporate governance as important run the risk of exposing themselves to a scandal.

'You can end up with a Volkswagen situation, where the board situation was appalling and they had a scandal,' he notes.

Citing US and UK banks that ran into trouble during the credit crisis, alongside Volkswagen's 2015 scandal involving emissions tests cheating, White suggests that they all share similar issues relating to the way their boards were constructed, alongside a lack of supervision and accountability of executives and non-executives.

'I think it is intrinsically important to look at corporate governance. Ignore it at your peril,' White concludes.

EdenTree likes to see that a company's corporate governance code is supported at a national government level by a guide to best practice.

Corporate governance standards are generally quite high in the UK. However, it is worth pointing out that standards are much lower in emerging markets, so investors should consider this before investing.

Fund managers getting involved with corporate governance doesn't simply mean voting against resolutions at AGMs. Many asset managers seek to engage with a company as soon as potential problems are identified.

'We generally like to engage behind closed doors because it tends to be more effective than bringing things out in the open,' says Jessica Ground, Schroders' global head of stewardship.

During the first half of 2016, Schroders carried out 86 governance engagements with UK companies. These tackled issues such as succession planning, corporate strategy, board oversight, remuneration and business ethics.

'Regulators and policymakers around the world feel shareholders can't be absent and benign. Our end-investors expect us to hold management to account and to make sure there aren't rewards for failures,' she notes.

'FUND MANAGERS NEED TO UP THEIR GAME'

For example, in 2015 Schroders voted against HSBC's proposed remuneration scheme because it was too focused on a fixed pay element and lacked disclosure on incentivised targets.

Schroders encouraged HSBC to address the issues and its efforts appear to have paid off. In 2016, HSBC changed its board significantly with five new non-executive directors, and has proposed a new remuneration policy.

Whilst Ground recognises that the asset management sector as a whole hasn't always been active or transparent about its voting activity at AGMs, Schroders has published voting records for years and does so on a monthly basis.

The group also recently decided to publish votes for international companies on a monthly basis. 'We recognise that fund managers need to up their game and this is what we are trying to do,' she adds.

Mike Everett, a governance and stewardship director at Standard Life Investments, agrees there is scope for some asset managers to raise their game when it comes to engaging with companies.

This is particularly true in relation to how fund managers adhere to the UK Stewardship Code. This was first published in 2010 and sets out principles for fund managers to act as effective stewards of capital. It currently has 300 fund group signatories.

'We signed up for the UK Stewardship Code and we think it is important, but we recognise there is a spectrum of adherence to it. We have written a paper about how we think we can raise standards more widely,' Everett says.

In his opinion, fund managers could benefit from being more transparent regarding their activities and how they adhere to the principles they agreed to in the code.

'I think there needs to be an improvement in transparency to get everyone to a level that is similar, so we can see how much an asset manager does or does not do,' Everett adds.

Standard Life Investments has had a governance team in place since 1992, which, as part of the investment process, conducts detailed analysis on environmental, social and governance (ESG) factors affecting individual companies.

Everett says it protects the value of investments. The team spends a lot of time looking at whether company boards are diverse enough, and is involved in setting or challenging the strategy for the business.

PASSIVES CARE TOO

Company engagement isn't just the domain of active managers. Vanguard, which is one of the world's largest ETF providers with $2.5 trillion invested in global equities, has a team of analysts dedicated to corporate governance.

As Vanguard typically takes a passive approach, the group's head of corporate governance Rob Main describes the company as 'the ultimate long-term investor'. 'That long-term orientation really influences how we vote and engage with our portfolio companies,' Main adds.

The team examines the effectiveness of boards in place, given that they represent shareholders' interests.

It focuses on making sure the governance structures that companies have in place empower shareholders, and also considers whether executive compensation plans are sensible and encourage long-term performance.

Over the last year, Vanguard has carried out over 800 engagements with the companies it holds across its funds.

'We can impact change through voting, but we think it is just as important to engage with portfolio companies. This is a process rather than a one-time event. It is important for companies and boards to engage with shareholders on an ongoing, long-term basis,' Main concludes.

DOES ENGAGEMENT GENERATE BETTER RETURNS?

A study by Elroy Dimson, Oguzhan Karakas and Xi Li, published in August 2015, suggests so. The authors concluded that investor engagement can improve a company's financial performance.

They found that companies outperformed expected returns by more than 4 per cent after the first year of investor engagement with a company.

When investors engaged with companies on the issue of climate change, this led to a return of 10.6 per cent above the expected level.

A buy and hold analysis also showed that successful engagement on corporate governance issues resulted in a 7.5 per cent return above expectations after one year, while engagement on non-corporate governance issues generated an extra 5.9 per cent in performance.

The study was based on a data set of 2,100 corporate social responsibility engagements with more than 600 US-based companies between 1999 and 2009.


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