Activist Investor’s influence on Passive Funds

The cover story from this week’s Economist caught our attention, particularly as it relates to a number of IR themes we have been observing closely. Academic literature* examining the recent track record of US activist investors concludes that despite their reputation and short term focus they are more often than not a force for good, at least in terms of driving greater operating performance and shareholder returns.

The article draws attention to a polarity in today’s average shareholder structure, one that is particularly evident in the US. On one side of the spectrum is ‘lazy money’ which comprises a growing number of computer-run index tracking funds, ETFs and mutual or pension funds, which generally prefer not to get too involved in radically altering the strategic direction of the companies they invest in. On the other are large funds which buy entire companies, often taking them private and actively dictating strategy.

Activist investors can fill a key corporate governance void by influencing passive funds and ‘lazy money’ to take an interest and support either the activist investor or management’s chosen course of action. The long-only funds holding the majority of the free float generally assume the role of ‘blocker’ or ‘enabler’ for activist campaigns so the more involved they are the better. This involvement looks set to increase as activist funds grow in popularity. In 2014, a fifth of flows into hedge funds went to activist investors, resulting in their AUM rising from $55bn to $120bn over a 5-year period.

The two largest providers of passive products, Blackrock and Vanguard, have already pledged to work more towards ‘long term interests’; this will inevitably include increased contact with company boards. Company management and IR teams may also make a more proactive effort to establish relationships with passive managers, something which was not really considered as recently as a few years ago.

The final angle of the debate centres around the potential for transferring the US-style activism model across the Atlantic, particularly given the arguably limited opportunities in the US (only 76 companies in the S&P 500 registered a poor 5-year Return on Equity and only 29 trade below their liquidation value). European investors will argue that they already have more say than their American counterparts on corporate governance issues such as renumeration and board appointments, and differences in culture as we move east mean that many activist fund demands are often settled discretely and diplomatically.

* Long Term Effects of Hedge Fund Activism, Lucian A. Bebchuk,  WSJ

Corporate Governance Summer Series: The Investor Forum

Welcome to our  Corporate Governance Summer Series of posts, where we will aim to talk about some of the today’s ‘big picture’ developments that are shaping discussions around governance and engagement in today’s rather rapidly evolving capital market. Many of the initiatives we touch on such as the Investor Forum, the Kay Review, Integrated Reporting framework or the Stewardship Code converge the worlds of Corporate Governance and Investor Relations as we see it and therefore are worthy for us to examine in little more depth. Despite the fact that many of the developments we talk about are UK or US centric, we feel the implications, over time , will be global for both institutional investors and listed companies.

Today we look at the establishment of the UK’s “Investor Forum”, a group of global long-term investors seeking to promote greater strategic engagement with public companies listed in the UK.

Background

The Investor Forum was created by the Collective Engagement Working Group. This Working Group was set up in London in April 2013 and supported by Insurance, Pension Fund and Investment Management trade bodies in the UK. It was formed in response to the Kay Review on equity markets and long-term decision making. Its objective was to identify how investors might be able to work together in their engagement with listed companies to improve both sustainable, long-term company performance and overall returns to end savers. The recommendation to create the Investor Forum, as well as proposed structure and mandate were outlined in their December 2013 report. Consequently, the Investor Forum was formally launched on 2nd of July, 2014.

What are they key conclusions of this working group? 

  • Cultural change is needed.  Asset owners, asset managers and companies need to develop a shared sense of partnership, with the objective of promoting long-term strategies for prolonged competitive advantage at companies. This should lead to sustainable wealth creation for all stakeholders.
  • For companies: Major listed companies will be asked to hold an annual strategy meeting for institutional investors, outside the results cycle, where investors and company executives can link governance to the company’s long-term strategy without the focus on short-term results.
  • For investors: Engagement on governance issues should be integrated into the investment process.

What is purpose of the new Investor Forum? 

Broadly speaking, the purposes of the Investor Forum are to improve long-term returns from investment in companies by :

  1. Promoting the value of long-term approaches to investment to match the long-term objectives of the individual savers who are ultimately the beneficiaries of the long-term returns delivered by investment management
  2. Promoting cultural change throughout the investment chain – encompassing asset owners and their advisers, as well as asset managers and investee companies.
  3. Forming Engagement Groups to drive constructive change when there is a critical mass of support among Forum participants that a company is failing in some way that might compromise long-term returns.

Proposed Structure

Screen Shot 2014-07-27 at 23.31.06

With the recent FCA legislation banning the use of dealing commission to pay for corporate access, the UK will be an interesting test case and if effective, may herald a cultural paradigm shift in the world of international investor relations. A shift which calls for strategic engagement, transparency and focus on the ‘long term’. The culture change may take a while to catch on, but it can only spell progress for both companies and investors.

Overall, closer collaborating and better engagement has been shown to be key in investor relations and good corporate governance. The long-term approach has to be understood as having a different meaning to each investor, however, with the new engagement framework being championed by the Investor Forum and others, this mutual understanding can be sought.

Sources: Investor Forum, Investment Management Association

12 Steps to Best Practice ESG Reporting

We spotted this in F&C’s Corporate Governance Guidelines document published earlier in the year, and took the liberty to share. Particularly interesting for IR teams responsible for communicating ESG matters to investors.

Basic: 

  • Identify significant ESG risks and opportunities for the business
  • Establish and explain board accountability for ESG issues
  • Set out policies for significant ESG issues and explain how they are implemented and monitored
  • Establish and disclose targets and Key Performance Indicators for significant ESG issues covering global operations
  • Describe systems for training board members and staff on ESG issues
  • Report on performance against policies

Best Practice:

  • Explain how ESG policies link to key operational and financial drivers
  • Describe procedures for consulting key stakeholders and provide feedback on the range of views
  • Discuss challenges and set-backs as well as success stories
  • Describe procedures for verifying data including external verification
  • Take account of widely-accepted reporting standards such as the Global Reporting Initiative
  • Describe how ESG objectives are embedded into the corporate culture, including how they are reflected in remuneration policies and other performance management tools

Source: F&C, Global Corporate Governance Guidelines, January 2014