Beyond the rubber stamp: fund managers and the stewardship dilemma

An equity fund manager detects the seeds of disaster at a company she invests in: perhaps BP skimping on safety ahead of the Macondo oil spill, or funding problems at the lender Northern Rock before the financial crisis.

Should she simply sell the stock, protecting her investors from the problems that may lie ahead? Or should she lobby the company's board, try to influence the top management, and stick with the company until it improves? What would you, as an investor in the fund, prefer?

A decade or so ago, many fund managers would have chosen the first option. Helena Morrissey, chief executive of Newton Investment Management, has spoken publicly of exactly this dilemma: her company spotted problems at Northern Rock and sold out by 2005. Investors were better off for it, but looking back, Ms Morrissey now wonders whether they could have done more to prevent the company's eventual meltdown.

She is not the only one to think this way. Tasked by the government with reviewing short-termism in equity markets after the financial crisis, the economist John Kay found in 2012 that "promoting good governance and stewardship is… a central, rather than an incidental, function of UK equity markets".

A series of initiatives since then has sought to improve the ways in which fund managers engage with the companies they invest in, and ensure they do not simply rubber-stamp decisions made by company boards. For example, about 300 asset managers have signed up to a UK stewardship code that has become a model for others around the world.

But the Financial Reporting Council, which monitors the code, this year warned fund managers they could be struck off the list if they treat stewardship simply as a box-ticking exercise. David Styles, director of corporate governance at the FRC, says that "some are excellent, but it is patchy. We need to examine whether asset managers are actually doing what it says on the tin."

Executive pay packages are by far the most high-profile area in which shareholders engage with companies. The government last year handed shareholders the ability to throw out overly generous executive pay policies, in a move that partly stemmed from public outrage over bankers' pay during the financial crisis.

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The spotlight has instead turned to asset managers themselves; campaigners argue that as their own salaries and bonuses rise, they are becoming less likely to hold other companies to account.

"On current trends, asset managers' pay is set to overtake investment bankers' by next year," says Catherine Howarth, chief executive of ShareAction, a responsible investment campaign group.

"It's not easy to challenge companies on pay and call them out when your own firm is culpable of the same problem. It's the pot calling the kettle black."

However, some asset managers are prepared to be relatively aggressive on pay, according to data from Proxy Insight, a research firm.

Among these is Aviva Investors, the fund arm of the insurance company, which has voted against companies' remuneration reports 35 per cent of the time, and has voted against management in 32 per cent of all votes.

On remuneration policies, which set out a company's overall approach to pay, Fidelity Worldwide Investment voted against management in 54 per cent of cases.

F&C Asset Management and Threadneedle are also among the firms that are more likely to oppose pay packages; F&C voted against remuneration reports 23 per cent of the time and Threadneedle was 17 per cent, Proxy Insight said. But among many other asset managers, support for management remains the norm.

In holding companies to account, boards are meant to be the first port of call. Paul Lee, who joined Aberdeen Asset Management as head of corporate governance in January, says engagement can often take the form of lobbying for the appointment of new, assertive directors at a point when a company is becoming complacent.

"The biggest problems in corporate history are all about companies that have performed really well and management starts to believe what's written about them," he says.

"They need to be reined back in a bit, to be challenged.

"The cases where it really works are the ones where the disaster didn't arise - we got the right people in the boardroom at the right time, and the problem didn't hit the radar screen."

Mr Lee says he is currently engaged in such a situation, pushing a company that is "a bit overly loved by the market" to bring in strong new directors as the chairman approaches the end of his time in the role.

Some shareholders attempted similar action at Tesco - a company which could do little wrong for over a decade but which has been plunged into crisis by a £263m profit overstatement and a dividend cut.

"There were a number of us who raised concerns about the issues, like the move that they did into the US," says Mr Lee. "This was perhaps a situation where if shareholders had collectively managed to be more robust, the challenge might have come in a bit earlier."

A new initiative set up in the wake of the Kay review, the Investor Forum, will create investor groups to engage collectively with companies on mid- and long-term issues, aiming to limit the risk of "strategic or operational drift". But the forum remains in its early stages.

Iain Richards, head of governance at Threadneedle, says that ensuring good quality boards is often little appreciated because it takes place behind the scenes, making it difficult for outsiders to assess asset managers' efforts.

Instead, investors must rely on voting records, data from companies such as Proxy Insight, and the ways in which companies explain themselves.

A yearly survey by ShareAction crowns Threadneedle Asset Management most responsible, followed by Aviva Investors and Jupiter Asset Management.

At the bottom of the table, UBS Global Asset Management, M&G and Santander Asset Management are labelled as among the least convincing on stewardship - and many large UK asset managers vote with the management of the companies they invest in more than 90 per cent of the time, according to Proxy Insight.

While retail investors are unlikely to spend time poring over asset managers' voting records, Ms Howarth says stewardship is still worth taking into account, particularly where an investor is in for the long term.

"Stewardship is a big aspect of [investment] performance. A skilful fund manager can have a real influence over what companies do - this is an area where asset managers can really add value for clients," she says.

Jonathan Cobb, investment director for corporate governance at Standard Life Investments, says his company operates a "health warning" system under which teams pay extra visits to companies showing signs of failure in corporate governance.

The reputation of asset management has faced a battering in recent years; critics have attacked the industry over costs and investment performance. Stewardship may provide an opportunity for them to prove they are about more than gathering assets and collecting charges.

Mr Lee argues that stewardship is a way for fund managers to show they are useful to society. "If we can help companies to do their jobs better and deliver more value, then the pot is bigger at the end of the day."

But Ms Howarth is not optimistic, identifying a "fundamental misalignment" between the interests of asset managers and their customers.

"All the drivers for the companies are to accrue assets under management. For underlying savers, stewardship really counts but for asset managers it is just an expense line."

But she applauds initiatives aiming to make asset managers' stewardship records more easily available. The Labour party has pledged that if it wins May's general election, it will compel asset managers to reveal their voting records on executive pay at companies, an initiative Ms Howarth supports.

There are suggestions that consumers are asking more questions about stewardship, too; Mr Richards says his company is receiving a growing number of inquiries about factors like sustainability.

"People are becoming more selective. They want to know what they are involved with. They want to have an opinion. There's a groundswell of change taking place," he says.

As for asset managers themselves, Mr Lee says that "a lot of companies have acknowledged that this is an area where we need to do more work. Many have increased their teams and their discipline in this area".

But he warns: "There's still a bit of a danger that stewardship is a box in the corner - that it's seen as compliance-led rather than a business opportunity."

Passive fund managers are not passive owners. This is the message from Vanguard, one of the world's biggest managers of passive or index funds.

Although it would be surprising for Vanguard to state otherwise, Glenn Booraem, the US group's controller of funds, stresses the importance the fund manager places on corporate governance.

"As a passive manager, we have no choice but to stick with the companies we invest in because they are in the indices we track," he says. "We can't sell like an active manager can. We are permanent shareholders. It is like riding in a car that we can't get out of."

Like active asset managers, Mr Booraem says most of the engagement takes place behind the scenes."Our involvement has taught us that you can accomplish a lot through dialogue rather than voting alone."

In the UK, which has led the way on governance matters over issues such as binding votes for shareholders and the introduction of a corporate governance code, regulators are taking a fresh look at whether passive investors are carrying out their stewardship roles properly.

How can a group with thousands of equities on its books properly challenge and monitor each company? Groups such as Legal & General Investment Management, one of the UK's biggest passive investors, and Aberdeen Asset Management, which now has a big passive book after its acquisition of Scottish Widows Investment Partnership, say they take stewardship extremely seriously.

And in December, Vanguard demanded a big shake-up of relations between company directors and shareholders amid concerns about the quality of corporate governance in the US and abroad. It has also floated the idea of "shareholder liaison committees" in letters to company boards.

Bill McNabb, the Vanguard chief executive, said that it was wrong that many directors had never met shareholders in their companies, leaving the task to the chairman or a senior independent director.

Mr Booraem says Vanguard wants to make boards more accountable, not just on issues such as executive pay, but also strategy, auditing and succession planning.

"We want to make sure that the vast majority of boards and management teams are focused on long-term value objectives, like we are. As permanent shareholders, we have a key role to play in stewardship and responsible investing."

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