Kay Review recommendations tackle short-termism

Co-head of responsible investment at the £32 billion Universities Superannuation Scheme, David Russell, says asset manager engagement with companies should move away from its “almost myopic focus on remuneration” to other issues that impact value and strategy.

His comments come on the back of the final report of the Kay Review of the UK equity markets and long-term decision making. One of the recommendations in the report was to improve the quality of engagement by investors with companies.

Russell says the challenge for the industry is in the implementation of the recommendations.

“Whilst we welcome the general thrust of Kay’s recommendations, the challenge is going to be with the implementation of the recommendations and the steps necessary to kick-start the changes needed which Kay has highlighted.

Across the board asset owners and asset managers in the UK have largely welcomed the recommendations.

Martin Gilbert, chief executive of Aberdeen Asset Management, one of the biggest managers in the UK with £182.7 billion in assets under management, said he was “very supportive of John Kay’s findings”.

“As an asset manager, we have very low turnover of about 10 per cent annually because we believe it is best to buy a good company and hold on to it as long as we can,” he said. “By being a long-term investor, it helps with engagement and corporate governance. We can engage with companies and act as proper and responsible owners of their stock.”

There were many recommendations that would have a material effect on the structure and habits of funds managers including disclosure of fees, re-thinking remuneration and a move away from quarterly reporting.

“I’m sure UK companies would like to move away from quarterly reporting but I think it would be difficult. US investors which many UK companies wish to attract to diversify their shareholder register view quarterly reporting as standard.”

The overall conclusion of the report is that short-termism is a problem in UK equity markets caused primarily by the decline of trust and the misalignment of incentives through the equity investment chain.

The review sets out principles that are designed to provide a foundation for a long-term perspective in UK equity markets and describe the directions in which regulatory policy and market practice should move.

“The epic story of Ulysses tying himself to the mast to resist the call of the sirens demonstrates the length of the history of attempts to construct devices and institutions to combat our instinctive short-termism. The central question for this review is whether capital markets in Britain today dissuade or stimulate the search for instant gratification in the corporate sector,” John Kay says in the final review report.

Some of the key recommendations of the review include:

• Improving the quality of engagement by investors with companies
• Increasing incentives to such engagement by encouraging asset managers to hold more concentrated portfolios judged on the basis of long-term absolute performance
• Tackling misaligned incentives in the remuneration practices of company executives and asset managers, the disclosure of investment costs and in stock lending practices
• Reducing the pressures for short-term decision making that arise from excessively frequent reporting of financial and investment performance, including quarterly reporting by companies and from excessive reliance on particular metrics and models for measuring performance, assessing risk and valuing assets
• Companies should consult their major long-term investors over major board appointments
• Asset managers should make full disclosure of all costs, including actual or estimated transactions costs, and performance fees charged to the fund
• The Government and relevant regulators should commission an independent review of metrics and models employed in the investment chain to highlight their uses and limitations.

The review also recommends the establishment of an investors’ forum for institutional investors in UK companies.

USS’ Russell says ideas such as the investors’ forum are not new and it is uncertain of their impact.

“It remains to be seen if they will lead to this year’s increased voting and engagement activity becoming an established feature of the investment landscape,” he says.

“There also needs to be recognition that pension funds are broadening their holdings away from equities, particularly as defined benefit schemes mature. A consideration of what long term investment means for non-public equity holdings is essential in this context.”

Joanne Segars, chief executive of the National Association of Pension Funds whose members represent £800 billion says the report offers some useful, practical advances.

“Equity markets must work more effectively in the long-term interests of investors and savers, who need to be able to see that they are getting value for money.

“The NAPF is pleased to see Kay say that transaction costs and stock lending income should be set out more clearly. Boardroom pay must also become more transparent and more strongly linked to long-term performance.

“Most pension funds delegate responsibility for company engagement to an investment manager, and Kay is right that this relationship needs to be reshaped if good corporate governance is to develop further.

“Pension funds need to hold their managers accountable for delivering long-term returns, and quality stewardship should be a key factor when picking or reviewing investment managers. However, at present there are many competing priorities for trustees, and managers’ capabilities are difficult to assess.

“Our members regularly engage with companies on routine and more serious matters. This approach fits well with Kay’s suggestion of a forum to encourage collaboration among domestic and overseas investors, and it’s something funds will be keen to get involved in.

“We strongly support the FRC’s Stewardship Code and welcome the new best practice statements for asset owners. These could encourage pension funds to be more explicit in their expectations of their asset managers and more rigorous in holding them to account. We plan to incorporate the relevant parts of the statements into our Corporate Governance and Voting Policy and Guidance on the application of the Stewardship Code.”