Asset owners need to be more aware of the turnover in their equity managers’ portfolios, as it not only hides costs, but also acts as a proxy for the short- or long-term behaviour of managers.

A research paper produced by the 2° Investing Initiative, the Generation Foundation and Mercer analysed more than 3500 institutional long-only active equity funds in Mercer’s global investment database.

The analysis showed the equity fund managers replace all of the names in their portfolio every two years, on average. That equates to a share replacement rate of 1.7 years.

While optimal turnover for investment performance is not a well-defined concept, the report states, a review of literature on the subject points to a four-year holding period (25 per cent turnover) as a reasonable estimate of what’s optimal. That is well below the average turnover rate identified in this analysis, which is 58 per cent.

The report did show that turnover has declined over time, but only gradually.

“The decrease in turnover suggests increasing demand for longer-term investments from asset owners,” the report states. “There remains more room for turnover levels to fall among long-only active equity managers, before reaching equilibrium.”

‘Tragedy of the Horizon’

The 2° Investing Initiative and the Generation Foundation have formed a multi-year partnership to explore and address the “Tragedy of the Horizon”, which they describe as the “potential sub-optimal allocation of capital for the long term due to the limited ability of the finance sector to capture long-term risks within short-term risk-assessment frameworks”.

Their project aims to assess artificial and natural factors that compress the horizons of market players, such that long-term risks get mispriced. Such a mispricing of long-term risks creates a void between the assets and liabilities of long-term asset owners and can eventually amount to an asset-liability mismatch.

Their report, The long and winding road: How long-only equity managers turn over their portfolios every 1.7 years, looks at the impact of turnover on long-term investing. Mercer provided data and analysis.

“High portfolio turnover makes the investors’ decision-making process full of twists and turns, obstructing their view of long-term performance and an optimal allocation of capital for the long term,” the report states. “Giving investors a straighter road, or [having them] hold assets longer, may make them more efficient drivers and better fiduciaries in the long term.”

The paper focuses on the role turnover plays in the asset owner-asset manager relationship and how a deeper understanding of this particular variable during fund evaluation can help investors. Findings show that turnover is going down in professionally managed long-only equity funds, on average, despite rising overall sharemarket turnover. Most equity managers appear to do a good job of keeping actual turnover within or near initial expected levels, the report states.

Other findings were that quantitative strategies, on average, exhibit higher turnover than fundamental and blended strategies; and there are cases where managers seem to make suboptimal decisions due to their belief that clients could not tolerate short-term volatility. Also, managers commonly view the turnover ratio as an outcome of their process, not an input or end they pursue.

Encourage optimal behaviour

The report has some clear messages for asset owners. In particular, they should improve how they monitor and communicate with investment managers if they wish to encourage optimal behaviour.

Asset owners should:

Be explicit about their time horizon and expectations for how it will affect asset-class exposures and the types of investment managers and strategies they’ll employ. This could include a behavioural policy statement, for example, incorporated as an appendix to the statement of investment beliefs document; ideally, the beliefs would establish a clear set of actions that specify how the asset owner would be expected to react to short- and medium-term manager underperformance

Avoid making short-term decisions by designing a reporting framework for monitoring managers that looks beyond short-term price performance

Develop and promote a process to check manager behaviour against expectations; this may include looking at areas such as portfolio characteristics, level of portfolio turnover and drivers of portfolio activity

Compare actual performance against the hypothetical buy-and-hold performance of the portfolio over a given period, to assess the benefit of portfolio turnover

Ask for more detail regarding frictional transaction costs managers incur and develop a process to check manager behaviour against initial expectations

Be explicit about managers’ time horizons and how they expect it to affect their decision-making, the design of employee compensation and incentives, and expectations for how they will interact with clients

Include greater discussion of turnover and management of transaction costs in the ongoing management of the portfolio.

At the outset of 2017 – the Chinese Year of the Rooster – chief investment officers are acutely aware of the potential for the world’s politicians to wreak havoc with their plans. After a turbulent 2016, this could be the year when the risks of an unbalanced portfolio truly come home to roost.

This January, the world heard a promise by British Prime Minister Theresa May to implement a clean and hard Brexit from the European Union, followed by an incendiary inauguration speech from new US President Donald Trump. These two figures, who were at the centre of the biggest geopolitical shocks of 2016, are set to continue shaping global markets in the year ahead.

More worrying for investment chiefs is that there are so many potential geopolitical triggers for market upsets already pencilled in on the calendar.

Elections will be held in the Netherlands, France and Germany, and possibly in Italy and the UK. Far-right populist parties touting nationalistic, protectionist policies stand to gain ground in all those polls. A twice-a-decade leadership reshuffle in China, which is scheduled for the latter half of 2017, could throw up another wildcard.

These are just a few of the major geopolitical events investors are trying to plan for – what former US defense secretary Donald Rumsfeld would refer to as the “known unknowns”. But, of course, the biggest geopolitical shocks are always the unknown unknowns that no one sees coming.

“Any CIOs who think they have a handle on geopolitical risks are fooling themselves,” Statewide Super chief investment officer Con Michalakis warns. “The fact is, you can’t predict the future and history has shown that markets don’t price geopolitical risk well.”

What worries Michalakis is that in the current environment, with asset prices inflated from eight years of record low interest rates and extraordinary international monetary policy, even a small geopolitical shock might lead to major falls in global financial markets.

He has already re-positioned Statewide’s $7 billion portfolio to better withstand the inevitable volatility. This meant branching out into absolute returns and not being too reliant on equity risk, but still keeping some bonds for risk protection.

“At the moment, you want to be fairly diversified and take a little bit of risk off the table,” he says.

MLC chief investment officer Jonathan Armitage is also relying on diversification to protect the more than $100 billion portfolio he shepherds.

“Corporate profitability in the US and elsewhere will be subject to a number of different forces, which makes forecasting unusually challenging,” Armitage says. “The direction of government policy will also be an area that will be interesting, with a new administration in the US, presidential elections in France and the evolution of UK policy regarding Brexit.”

He says ensuring portfolios have adequate diversification will be especially important, given the heightened chance that both equity and bond markets could be set for a tumble.

“There is clearly an important question around whether the recent moves in bond markets, especially in the US, are temporary or reflect a more permanent shift in valuations,” he explains.

Armitage cites a well-timed shift out of long-dated US treasuries and into private credit as his best investment call of 2016.

Trump’s inauguration speech on January 20 painted a dystopian picture of the super power, with “rusted out factories scattered like tombstones across the landscape”, as he pledged to protect US borders from “the ravages of other countries”. Trump is spruiking a mantra to “make America great again” via a program to “buy American and hire American”.

However, Trump’s power over domestic reforms is dependent on having Congress on his side.

Geopolitical forecasters, including George Friedman and John Mauldin of Mauldin Economics, advise investors to pay attention to the actions of US Speaker of the House of Representatives Paul Ryan and the chair of the House Ways and Means Committee, Kevin Brady. Without these two Republicans onside, most of Trump’s domestic policies will be dead in the water.

Nevertheless, Trump remains a maverick with the potential to disrupt, as was demonstrated when a tweet he sent wiped $US4 billion ($5.3 billion) off Lockheed-Martin’s equity market valuation.

UniSuper head of global strategies and quant methods Rob Hogg is concerned about what Trump will do in the international realm, with his considerable power to reshape global trade policy.

“The question is whether we will see elements of protectionism, trade retaliation, or tariffs,” Hogg says. “Those sorts of elements are unambiguously negative for the growth of trade and also for investor sentiment.”

Hogg cautions that for all the geopolitical risks, investors should not forget that in the background there remain structural headwinds – such as baby boomers reaching retirement age and ongoing public and private debt – that need to be tackled as well.

In this stressed environment, China is emerging as the new international responsible citizen, supporting free trade and the Paris agreement on climate change.

With this in mind, Frontier Advisors director of capital markets and asset allocation, Chris Trevillyan, thinks that of all the geopolitical risks visible on the horizon, the one with the greatest potential to cause serious disruption for investors is the 19th National Congress of the Communist Party of China, slated for the second half of 2017.

The five-yearly congress marks a transition of leadership in the top ranks of China’s ruling Communist Party. In 2017, President Xi Jinping is almost certain to retain the top party spot of general secretary. However, there is much uncertainty over the other leadership positions.

“That could well be the most influential event, but it is the most opaque, so you don’t necessarily know in advance – or even afterwards – what has happened,” Trevillyan says. “Investors will have to wait to see how it plays out.”

The worry is that a desire to appear strong will lead China to take an even more aggressive stance in its territorial dispute with the US in the South China Sea, potentially sparking a war.

Trevillyan’s top piece of advice for institutional investors is to embrace portfolio diversification strategies.

Sunsuper listed shares manager Greg Barnes is also cautious about the potential fallout from trouble in the South China Sea.

The power struggle between Australia’s two largest trading partners could have big repercussions domestically, Barnes says. However, he is confident that Sunsuper’s $36 billion portfolio is well-positioned for these risks.

“We are in quite a reasonable period of market performance for equities, but it’s really about having a broadly diversified portfolio that can withstand the hiccups that invariably happen,” he says.

A significant allocation to high-quality unlisted assets, which have in recent times delivered both stronger returns and lower volatility than equity markets, is something Barnes tips to continue to pay off in 2017.

“[With] that kind of portfolio structuring, if there is a bump, we probably don’t go down as much; then we get back to compounding more quickly when the markets recover,” he says.

This article first appeared in the February print edition of Investment Magazine, sister publication to conexust1f.flywheelstaging.com. 

The dictionary definition of the word “optimal” is “best or most favourable”. While an investment strategy is hardly ever described as “the best” – perhaps for fear that this might sound somewhat hubristic or over-confident – it seems to be perfectly acceptable to describe a strategy as optimal, despite the same intended meaning.

So where did the over-use of optimal come from? Google’s chart of use over time shows that optimal was a word rarely used until around 1950, after which time its use grew exponentially. This supports the hypothesis that optimal entered the investment lexicon following the widespread adoption of mean-variance optimisation, which Harry Markowitz developed in the 1950s. Although the usage statistics for optimal have levelled off in recent years, the advent of robo-advice has given a fresh impetus for the use of mean-variance optimisation as a portfolio construction tool.

Mean-variance optimisation uses the expected returns, volatilities and correlations of a range of asset classes in order to arrive at an ‘efficient frontier’. Any strategy sitting on the efficient frontier maximises the expected return for a given level of volatility and is, therefore, described as efficient or optimal.

The problems with the term optimal as a descriptor of investment strategies are, therefore, intimately connected with the weaknesses of mean-variance optimisation as a portfolio construction tool. These include:

  • The use of volatility as the only measure of risk. As a result, volatility and risk have become synonymous, despite the fact that a highly volatile asset might be much less risky than one exhibiting low volatility if risk is viewed as the possibility of suffering a large drawdown or losing money in real terms, for example. This isn’t to say that volatility is useless as a measure of risk – far from it – simply that it shouldn’t be the only measure of risk.
  • Volatility and correlation inputs for a mean-variance optimisation process are typically backward-looking and assumed to be stable over time. The output based on such assumptions is, therefore, vulnerable to regime changes that materially alter correlation and volatility dynamics. Optimality based on backward-looking inputs is fragile when looking forward.
  • There are many possible approaches to setting the expected return assumptions that go into an optimisation, each with their own strengths and weaknesses. Different approaches can produce very different numbers but the high level of uncertainty in these assumptions is frequently ignored, with many of them often specified to an accuracy of two decimal places. Given the sensitivity of an optimisation to the input parameters and the high level of uncertainty inherent in the assumptions, to describe the output as optimal is misguided at best.

Mean-variance optimisation had not been invented when John Keynes wrote The General Theory of Employment, Interest and Money, yet the essence of the problem it has created is captured nicely in the following quote from the book: “Too large a proportion of recent mathematical economics are merely concoctions, as imprecise as the initial assumptions they rest on, which allow the author to lose sight of the complexities and interdependencies of the real world in a maze of pretentious and unhelpful symbols”.

This is not to say that mean-variance optimisation should be avoided altogether. With a clear-sighted recognition of its limitations, optimisation can be used sensibly as one input within a wide-ranging investment strategy discussion. Such a discussion would seek to address the many unquantifiable trade-offs investors face: the attractions of investing in less liquid assets vs. the opportunity cost of reduced flexibility; the costs and benefits of leverage; a desire to diversify vs. a preference for simplicity, among many others. This discussion should make use of a mix of quantitative and qualitative inputs, with expert judgement playing an important role.

Bias towards quantitative tools widespread

Many investors already follow such an approach when setting strategy and may consider this tirade largely unnecessary. However, a bias towards quantitative and precise numerical tools remains prevalent in the investment industry, as highlighted in Andrew Lo and Mark Mueller’s fascinating 2010 paper “Warning: Physics envy can be hazardous to your wealth”. Perhaps more worryingly, a few minutes spent on the websites of some well-known robo-advisers demonstrates that efficient frontiers and optimal portfolios are very much alive and kicking.

In today’s environment of heightened political uncertainty, with monetary stimulus of a type and on a scale never seen before, and with structural trends such as climate change, global ageing and technological disruption likely to change the investing environment radically, we need thoughtful, constructive debate like never before. An over-reliance on simplistic quantitative tools will lead to naïve portfolio construction, wrapped in a comfort blanket of “optimality”.

Instead, we need to face the radical complexity of the real world. Rather than aiming for some quantitative definition of optimality, we should seek the more humble and realistic aim of robustness under a range of plausible scenarios. Stress testing and scenario analysis – straightforward deterministic tools – provide a useful, powerful alternative to the relatively complex stochastic and optimisation tools that are more frequently used.

Optimality is an illusion – it’s time we removed it from the investment lexicon.

 

Phil Edwards is European director of strategic research at Mercer.

Ilmarinen, Finland’s third-largest pension fund, will continue to decrease its allocation to government bonds and investment-grade credit, primarily in Europe, in a strategy designed to protect the fund’s fixed income allocation from any interest rate move.

“I don’t see any value here at the moment,” Ilmarinen chief investment officer Mikko Mursula explains. “If interest rates begin to move up, it will mean capital losses for the longer maturity government bond portfolio. We have had quite a short duration in our fixed income portfolio for some years already.”

The €37 billion ($39 billion) fund now allocates 42 per cent of assets to fixed income. Its investment-grade credit comprises allocations that fall between government and corporate bonds and includes investment in state-owned enterprises and local government debt.

Ilmarinen has just posted a 4.8 per cent return for 2016, in a year marked by two distinct cycles: share prices fell initially, yet picked up towards the end of the year, helping to lift the whole portfolio.

“The market is not the easiest at the moment. But then, we always say this. It is never easy,” Mursula says.

He first joined Ilmarinen in 2000 and has held roles as head of equities, listed securities and tactical asset allocation. In 2010, he left to spend five years working for a Finnish asset manager before returning to Ilmarinen as CIO.

“It was good to go and see the world from an asset manager’s perspective. Being back on the buy-side is a bigger responsibility,” he says.

Looking outside of Finland

The plan is for assets taken out of fixed income to go into diversified equity and real assets instead. The bulk of Ilmarinen’s real-asset portfolio lies in real estate, which returned 6.4 per cent in 2016.

Most of the fund’s real estate assets (80 per cent) are in Finland, primarily in Helsinki’s metropolitan area. Efforts to increase the real estate portfolio from today’s 11 per cent of total fund assets will primarily target foreign opportunities.

“The current ratio is 80/20 local vs foreign real estate and this will change to 70/30 or even 65/35,” Mursula says.

Investments will focus on office space in Central European cities, including Brussels, Berlin and Frankfurt, as well as the US, where he favours residential and office properties.

He will continue to avoid the UK market, having put investment in UK real estate “on hold” after Brexit. The plunge in sterling, “pressure” on the market and uncertainty going forward are reasons to be wary.

“There are so many open questions about Brexit for investors,” he says. “We don’t know the time schedule or what will happen in the end.”

Less exposure to European equity

Mursula is also reducing the fund’s exposure to the European equity market as he works to boost equity overall.

Ilmarinen has a home bias in this asset class, with 30 per cent of its listed-equity portfolio in Finnish companies. The remaining 70 per cent is diversified between the US, Japan and Europe but the fund has already begun diversifying equity risk from Europe to the US and emerging markets. About a third of the overall portfolio is in listed equity.

“We used to be heavily concentrated in European listed equity and have been moving more investment to the US to diversify our risk. We will continue doing this,” Mursula says.

The majority of US equity investment is passive, using index funds and exchange-traded funds. In emerging markets, Mursula prefers active managers.

“In the past couple of years, there have been more index funds in emerging markets but we still believe the more undeveloped a market is, [the greater the] need for active investment.”

Eighty per cent of Illmarinen’s assets are managed in-house. The 20 per cent that is outsourced includes a portion of the active listed equity allocation in emerging markets, but also in Japan and the US.

Private equity, which accounts for about 5 per cent of assets, and the fund’s small allocation to alternative credit, are also managed externally. The fund uses more than 100 managers or funds across equities, fixed income and alternatives but doesn’t use consultants to manage its managers.

“We have a dedicated in-house team doing manager selection. This includes performance analysis in a strict and real-time process,” Mursula explains.

Fee negotiation becomes critical

He says fees are more important than ever in today’s low-yielding environment, and he carries out “case by case” fee negotiation with each manager.

Listed long-only equity managers tend to be flexible about fees, particularly if investors consider a large ticket size, he observes.

Fee negotiation with hedge funds and private equity managers is more challenging and he thinks many managers in these asset classes are struggling to justify high fees with poor performance.

“With convincing long track records, managers can stick to their existing fee structures,” he explains. “Now, lots of private equity and hedge funds are suffering from a lack of performance and track record and we are seeing the fees come down. But it is not just about fees. Managers struggling with performance are also finding it impossible to get new investors on board.”

Hedge funds account for 2.9 per cent of assets at Ilmarinen. Most of the allocation is managed in-house by “a significant hedge fund team” in a strategy that brings transparency and cost-effectiveness. The team focuses on catching market inefficiencies and mispricing in equities, foreign exchange, commodities, volatility and illiquidity premiums.

“There are some sub-asset classes or risk premiums that it is difficult to access in-house, one example of this is insurance risk,” Mursula says.

He says his investment team prides itself on a “flexible and fast” decision-making process shaped around the freedom to act decisively, within a framework the board sets annually.

 

What is leadership? Gianpiero Petriglieri, associate professor of organisational behaviour at INSEAD, will conduct a masterclass in leadership at the Fiduciary Investors Symposium, exploring how and where people become mindful, effective and responsible leaders.

In a conversational meditation on leadership, Petriglieri will ask delegates to contemplate what they think leadership is, how to recognise it and whether it matters.

“How did we end up where we are, with distrust and disillusionment with leadership?” he asks from his Fontainebleau office. “One thing I will ask people is, ‘Do you know why people trust you?’ People’s trust is the main thing you need as a leader.”

Petriglieri will open the conference with a session that explores two related questions – a broad social query and another more personal one.

The first question concerns the nature of leadership, what it is, and how one gains it and loses it. Determining who gets to lead and who doesn’t is never easy to do when people keep moving around.

The second query will dig deeper. Despite copious investment in leadership development, Petriglieri says, organisations claim to suffer from a shortage of leaders. And those who do lead often struggle to connect with potential followers, facing resistance and mistrust.

The session shall reach beyond superficial models and tales to address the key questions: What makes a leader in our times? What does it mean to lead well? What does it take for an individual?

Petriglieri’s interests bridge the domains of leadership, identity and learning. He is particularly concerned with the development of leadership in the age of “nomadic professionalism”, in which authenticity and mobility have replaced loyalty and advancement as hallmarks of virtue and success.

In this context, he contends, a narrow focus on the acquisition of new knowledge and skills is inadequate to develop competent and trustworthy leaders. His research casts a light on the psychological, social and cultural functions of leadership development.

His innovative teaching methods provide an example of how to perform those functions purposefully for the benefit of individuals, organisations and society at large. In addition to his academic background, he has the unique perspective of being a medical doctor and has practised as a psychoanalyst.

INSEAD has been rated the number one MBA school worldwide by the Financial Times for the second year in a row. Petriglieri directs the school’s management acceleration programme – which is its flagship executive offering for emerging leaders – and the INSEAD initiative for learning innovation and teaching excellence.

The Fiduciary Investors Symposium at INSEAD, Fontainebleau, will delve into these issues of leadership, organisational design and governance, alongside investment themes. Incorporating the school’s esteemed academic faculty, the program will explore business excellence alongside investment topics of risk management, environmental, social and governance integration, and illiquid investments.

Other faculty who will speak at the Fiduciary Investors Symposium include:

  • Macroeconomics – Ilian Mihov, Professor of Economics, dean of INSEAD, the Rausing Chaired Professor of Economic and Business Transformation
  • Digital disruption – Peter Zemsky, Professor of Strategy, deputy dean of INSEAD, the Eli Lilly Chaired Professor of Strategy and Innovation
  • Societal progress and the evolution of capitalism – Subramanian Rangan, professor of strategy and management, Shell Fellow in Business and the Environment, Abu Dhabi Crown Prince Court Endowed Chair in Societal Progress
  • Governance – Ludo Van der Heyden, academic director of the INSEAD Corporate Governance Initiative, professor of technology and operations management

 

The Fiduciary Investors Symposium will be held at INSEAD, Fontainebleau, France from April 2-4. To access the program and to register click here.

 

The California State Teachers’ Retirement System (CalSTRS), the Florida State Board of Administration and Washington State Investment Board are the lead asset-owner signatories for the Investor Stewardship Group (ISG). This collective of some of the largest US-based asset owners and managers has articulated a set of fundamental stewardship responsibilities for institutional investors.

Among the asset-manager signatories are BlackRock, Vanguard and State Street Global Advisors – three of the largest funds managers in the world.

In addition to the stewardship fundamentals, the group has released a corporate governance framework that articulates six principles it considers fundamental for US-listed companies. They reflect the common beliefs embedded in each member’s proxy voting and engagement guidelines, and are designed to establish a foundational set of investor expectations about governance practices in US publicly traded companies.

The frameworks are long overdue. The US – the largest sharemarket in the world – operates without any stewardship code or agreed-upon corporate governance principles.

Allison Bennington, partner at San Francisco-based investment company ValueAct Capital, another one of the founding ISG signatories, says there is much overlap among the policies of the group’s members, and this helped create the framework.

“This could be useful for the companies themselves. [It] helps companies focus on standard corporate governance terms,” Bennington says. “Directors are accountable to shareholders but we wanted to show we are accountable to our members and stakeholders.”

Aeisha Mastagni, portfolio manager, corporate governance, at CalSTRS, also says it’s important that investors show their accountability to members.

“It’s about their savings and retirement, so we should be accountable,” Mastagni says. “Engagement between investors and issuers has grown exponentially; now is an important time to have this in place. [It’s about] management and board being accountable to shareholders and us as shareholders being accountable to our beneficiaries.”

She pointed to the issue of dual-class shares – highlighted again recently by the Snapchat float, which has three classes of shares, including those available to the public that have no voting rights – as an example of why good principles are essential.

“With dual voting rights, we lose our accountability,” Mastagni says. “We can’t hold the company to account.”

Bennington concurs that the economic interest should reflect the voting interest.

Large role for voluntary codes

Fiona Reynolds, managing director of Principles for Responsible Investment (PRI), says the ISG code is a significant step forward.

“It is a voluntary code, but has some big investors behind it, which I hope means it will gain widespread support,” she says. “Anything that helps investors focus on long-term risks and opportunities is a step in the right direction. We have already seen attempts to wind back parts of [the Dodd-Frank Wall Street Reform and Consumer Protection Act] in the US. If regulation is wound back, then voluntary codes may have to play an increasing oversight role.”

The PRI undertook some research in late 2016 mapping regulation, including codes that underpin responsible long-term investing. The research shows that companies in countries with mandatory, government-led, comprehensive environmental, social and governance (ESG) reporting requirements have, on average, a 33 per cent better MSCI ESG rating than those without. The score indicates better ESG risk-management practices relative to risk exposure.

“We also tested the relationship between voluntary ESG disclosure requirements [and the MSCI ESG rating],” Reynolds says. “We found a small positive relationship (+11 per cent), but it was less significant than with mandatory regulations. So stewardship codes, while not as impactful as regulation, do make a difference. But there [must] be oversight of the stewardship codes, and reporting against them, to make them meaningful.”

Already a global trend
The US has been slow to the party. The first stewardship code was published in 2010 by the UK’s Financial Reporting Council, in response to criticism about the role of institutional investors in the lead up to, and during, the financial crisis.

The code’s 2012 revision clarified the respective stewardship responsibilities of asset managers and owners, including for activities they have chosen to outsource or undertake in collaboration with others. The UK Stewardship Code now has about 300 signatories and is implemented on a ‘comply or explain’ basis.

After the publication of the UK code, other countries established their own. The Netherlands’ Best Practices for Engaged Share-ownership was developed by Dutch corporate governance forum Eumedion; South Africa launched its Code for Responsible Investing in SA; and Switzerland unveiled its Guidelines for Institutional Investors Governing the Exercising of Participation Rights in Public Limited Companies.

One of the most significant launches of a stewardship code took place in Japan in 2014. To date, the country’s Principles for Responsible Institutional Investors is the only country code, apart from the UK’s, to have been drafted by a regulator, Japan’s Financial Services Agency.

Hot on the heels of Japan, Malaysia launched its Malaysian Code for Institutional Investors in 2014 as well. It is the second code in emerging markets, after South Africa’s. Other markets that have followed suit include Taiwan, Hong Kong and Singapore. South Korea and Brazil are looking at launching their own as well.

Six of the 14 countries that have developed stewardship codes since 2014 are in Asia, the PRI states. Codes have typically been modelled after the UK Stewardship Code; they set out principles that aim to improve engagement between investors and companies to help improve long-term, risk-adjusted returns.

 

ISG stewardship framework for institutional investors

Principle A. Institutional investors are accountable to those whose money they invest.

A.1 Asset managers are responsible to their clients, whose money they manage. Asset owners are responsible to their beneficiaries.

  1. 2 Institutional investors should ensure that they, or their managers, as the case may be, oversee client and/or beneficiary assets in a responsible manner.

Principle B. Institutional investors should demonstrate how they evaluate corporate governance factors with respect to the companies in which they invest.

B.1 Good corporate governance is essential to long-term value creation and risk mitigation by companies. Therefore, institutional investors should adopt and disclose guidelines and practices that help them oversee the corporate governance practices of their investment portfolio companies. These should include a description of their philosophy on including corporate governance factors in the investment process, as well as their proxy voting and engagement guidelines.

B.2 Institutional investors should hold portfolio companies accountable to the Corporate Governance Principles set out in this document, as well as any principles established by their own organization. They should consider dedicating resources to help evaluate and engage portfolio companies on corporate governance and other matters consistent with the long-term interests of their clients and/or beneficiaries.

B.3 On a periodic basis and as appropriate, institutional investors should disclose, publicly or to clients, the proxy voting and general engagement activities undertaken to monitor corporate governance practices of their portfolio companies.

B.4 Asset owners who delegate their corporate governance-related tasks to their asset managers should, on a periodic basis, evaluate how their managers are executing these responsibilities and whether they are doing so in line with the owners’ investment objectives.

Principle C: Institutional investors should disclose, in general terms, how they manage potential conflicts of interest that may arise in their proxy voting and engagement activities.

C.1 The proxy voting and engagement guidelines of investors should generally be designed to protect the interests of their clients and/or beneficiaries in accordance with their objectives.

C.2 Institutional investors should have clear procedures that help identify and mitigate potential conflicts of interest that could compromise their ability to put their clients’ and/or beneficiaries’ interests first.

C.3 Institutional investors who delegate their proxy voting responsibilities to asset managers should ensure that the asset managers have appropriate mechanisms to identify and mitigate potential conflicts of interest that may be inherent in their business.

Principle D. Institutional investors are responsible for proxy voting decisions and should monitor the relevant activities and policies of third parties that advise them on those decisions.

D.1 Institutional investors that delegate their proxy voting responsibilities to a third party have an affirmative obligation to evaluate the third party’s processes, policies and capabilities. The evaluation should help ensure that the third party’s processes, policies and capabilities continue to protect the institutional investors’ (and their beneficiaries’ and/or clients’) long-term interests, in accordance with their objectives.

D.2 Institutional investors that rely on third-party recommendations for proxy voting decisions should ensure that the agent has processes in place to avoid/mitigate conflicts of interest.

Principle E: Institutional investors should address and attempt to resolve differences with companies in a constructive and pragmatic manner.

E.1 Institutional investors should disclose to companies how to contact them regarding voting and engagement.

E.2 Institutional investors should engage with companies in a manner that is intended to build a foundation of trust and common understanding.

E.3 As part of their engagement process, institutional investors should clearly communicate their views and any concerns with a company’s practices on governance-related matters. Companies and investors should identify mutually held objectives and areas of disagreement, and ensure their respective views are understood.

E.4 Institutional investors should disclose, in general, what further actions they may take in the event they are dissatisfied with the outcome of their engagement efforts.

Principle F: Institutional investors should work together, where appropriate, to encourage the adoption and implementation of the Corporate Governance and Stewardship Principles.

F.1 As corporate governance norms evolve over time, institutional investors should collaborate, where appropriate, to ensure that the framework continues to represent their common views on corporate governance best practices.

F.2 Institutional investors should consider addressing common concerns related to corporate governance practices, public policy and/or shareholder rights by participating, for example, in discussions as members of industry organizations or associations.

ISG corporate governance framework for US-listed companies 

Principle 1: Boards are accountable to shareholders.

Principle 2: Shareholders should be entitled to voting rights in proportion to their economic interest.

Principle 3: Boards should be responsive to shareholders and be proactive in order to understand their perspectives.

Principle 4: Boards should have a strong, independent leadership structure.

Principle 5: Boards should adopt structures and practices that enhance their effectiveness.

Principle 6: Boards should develop management incentive structures that are aligned with the long-term strategy of the company.