Hermes Conference Blog

Will the investment industry rise to the challenge?

Tue, 24 Nov 2009 10:28:00 -0800

Following Mr Myners’ keynote speech, Glyn Jones remarks: “We have to rise to the challenges set out by Paul if we are to survive and prosper as an industry.”

The challenges are many and varied, but the key thread running through them all is that fund management and its larger institutional clients have a bigger role to play than they currently perform. A few take responsible investment seriously, but even these exceptions focus fairly narrowly on the quoted universe of companies.

Firstly, more investment firms need to take up the challenge, so the burden does not rest with one or two players. In the absence of support for better governance, the authorities will feel compelled to act.

Secondly, investors should look across the asset classes to see how they can improve sustainability in real estate, commodities, hedge funds, private equity and so on.

Lastly, fund management firms need to make sure they align their own structures with those of their investors. Only in this way can they assume a credible position when talking to companies and firms managing underlying investments.

And that concludes the conference. Thank you for taking the time to log in to this blog.

Please go to: www.hermes.co.uk for more information on responsible asset management.

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Governance vacuum will lead to next crisis

Tue, 24 Nov 2009 10:15:40 -0800

Paul Myners, Financial Services Secretary at the Treasury, former chairman of Gartmore, one of the UK’s largest investment firms, and former chairman of Marks & Spencer, warns that shareholders are “sleep-walking their way to another financial crisis”.

He says: “Institutional investors have the power to act and intervene in companies but most have been reluctant. Most argue – correctly - that clients show little interest in ownership and look at short-term performance only. It is ridiculous that pension funds that need to meet liabilities over three to four decades focus on investments over 90-day periods.

“Asset owners leave governance in the hands of junior employees with little or no experience of doing business. Many want to free-ride on the efforts of others. So government has had to step and take a lead in remuneration and risk management. Investors had the power to ask for change, but chose not to.

“There was effectively market failure, so the government has a responsibility to act.”

Well-run companies are founded on good governance, Mr Myners says. “If the banking crisis has taught us anything, it’s that bad decisions went unchallenged. Good governance needs good judgement, robust decisions and requires owners to care.

Good judgement is fundamental, but it is in danger of being overlooked as all the focus is currently on supervision. “Underpinning all the problems, is a failure of judgement by boards of companies, their banks and their shareholders.”

How do we improve judgement, Mr Myners asks. “Improving governance is the best mechanism. The contrarian voice must be heard, the voice that says ‘this is not good idea’. That might relate to the viability of wholesale funding or to liquidity or other factors. But the voice must be persistent.”

Mr Myners is clear with whom the responsibility lies for improvement in the future. “Shareholders need to be the drivers. It lies fairly and squarely with the owners of companies, not government and regulators.

“Shareholders should not be gamblers, they are owners. But many with hindsight were simply at the races. Most do not believe they are owners, do not feel responsible for companies. Ownerless corporations disadvantage public equity, because agents are not held to account by owners.

He warns that this will lead to future potential losses for investors. “The pressure to change will come from government, regulators and creditors, and the cost will be real - reducing income for shareholders.

The government will ensure that shareholders have the information necessary to challenge boards on their risk appetite and alignment on remuneration. “Shareholders were disinterested in restoring this balance.”

Mr Myners concludes with a call to arms for the asset management industry. “Fund managers say that most clients do not demand active governance so why do it? This argument is defeatist. The best businesses do not follow market trends, they set out to lead the thinking of their clients. More fund managers should go out and sell their ability to add value through governance.

“The investor case for active governance is at least as strong as for active stock picking, but I don’t see billboards advertising this. So why not make good governance an important selling point?”

He says individual firms must rise to the challenge. “But good governance does not come cheaply. Only as a result of an industry-wide effort can we drive effective board performance.

“Without significant steps forward, the ownerless corporation will sleepwalk into another financial crisis. The time for better stewardship is now.

“That means owning up to ownership.”

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Conflicts of interest prevent more effective SRI

Tue, 24 Nov 2009 07:24:00 -0800

While many fund managers have launched SRI funds or have incorporated SRI principles into their fund ranges, there are still many obstacles to applying ethical criteria to investment. David Pitt-Watson, chairman of Hermes Focus Asset Management, an activist investment firm, says: “I’m a big believer in private capital markets, but they don’t cope very well with public goods, such as the environment. It is a fact that a company that doesn’t spend a load of money cleaning up pollution will be worth more than a company that does. We have to think about how we can overcome that.”

The widespread adoption of investors everywhere of diversification principles only made these issues more difficult. “Investors now take smaller stakes in ever more companies and securities,” says Mr Pitt-Watson. “Mathematical models prove that if you have a lot of investments, you get the same return for less risk. But it also means that people are less and less interested in acting like owners.”

But there is good news too, in that there are natural incentives to adopt SRI principles. “Most investment managers have millions of beneficiaries, mainly ordinary people, so it is crazy to suggest that it is in their interest to invest in and encourage a company to destroy the environment to put threepence more in someone’s pension.” Other investors will take up the cudgel because they believe they will achieve higher returns by investing in ethically sound companies.

However, collective action needs to be taken to address the major underlying obstacles to the progress of SRI, Mr Pitt-Watson adds. “We need to bite bullet on the public goods and diversification issue. It is in all beneficiaries’ interest to encourage SRI. That does not mean spending lots of money and being a mini-Oxfam, but making sure companies are run sustainably. We all need to act together to get this to work, just as we would act to get together an army or a police force.”

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AIFM directive sparks debate on compensation

Tue, 24 Nov 2009 06:32:00 -0800

The appendix to the Alternative Investment Fund Managers Director by the Swedish presidency is producing lively debate. The appendix, if it remains when the final draft is issued, would restrict the compensation packages of individual hedge fund managers, bringing them into line with G20 principles.

Gavin Boyle, chief executive of Tudor Capital Europe, an offshoot of one of the most famous hedge funds in the US, says: “Business issues require us to be careful with remuneration policy so we already meet a lot of what is in the appendix. A reasonable portion of traders’ compensation being deferred for a couple of years is sensible. I don’t think many hedge funds will be far from this position.

However, Andrew Baker, chief executive of AIMA, says the appendix is ill thought-out. “There is nothing wrong with a series of high level statements and principles. Where it gets difficult is when wording is lifted from the Capital Requirements directive and cut and pasted into this one. It applies to banking but not to the investment management industry. So there are interesting negotiations to be had to make sure the wording is meaningful to the asset management industry. The key phrase is: alignment of interest. If compensation is appropriate, demonstrable and published in the prospectus, that is the limit of what we should get to.”

Matteo Perruccio, chief executive of Hermes BPK Partners, a funds of hedge funds firm, says a focus on individual managers is unnecessary arguing that if the firm is compensated appropriately, the managers will necessarily be too. “If the firm has a staggered or 3-4 year rolling fee structure, the issue takes care of itself and it will be naturally aligned with investors.”

Philip Read, chairman of the British Coal Staff Superannuation Scheme, argues that this does not work because fees at firm level are simply too high. “The average pension we pay out is £5,000 to £8,000 a year – it is these people’s collective money that is providing the capital to the hedge fund industry. Hedge fund managers have to realise we give money for them to deliver good pensions, not two and twenty fees. Perhaps a 15 per cent performance fee would be appropriate over the longer term. But the fixed fee is too high, especially given the shock of poor returns last year. Funds of hedge funds did not do what it said on the tin: solid returns, low volatility, capital preservation.”

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Are high trading strategies irresponsible?

Tue, 24 Nov 2009 04:47:42 -0800

Does frequent trading by fund managers represent irresponsible fund management and result in lower returns to investors? Ian Wace, chief executive of Marshall Wace, one of Europe’s largest and best-performing hedge funds, says not.

“We manage an active trading fund and I do accept there are frictional charges,” says Mr Wace. “If we have turnover of 15 to 20 times per annum and it cost 30 basis points to turn the assets that implies a 6 per cent charge per annum. People could say ‘how can you justify that?’. I reply that if you provide 14.59 per cent of absolute return after fees and the 6 per cent charge, then it could be justified.

“I go to huge lengths to find where the alpha is, and I don’t pay a penny more than I want to pay for transactions.”

He notes that passive investors have made no money in stock markets over the past decade or so. “When I look at returns, over the last 12 years equities are unchanged while we have provided 400 per cent compound returns because of the turnover in our funds. So who’s wrong?”

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Regulation could create "new credit crisis"

Tue, 24 Nov 2009 04:35:55 -0800

The misapplication of regulation could result in a crisis as bad or worse than last year, according to Stephen Green, chairman of HSBC Holdings. “Getting regulation right is critical: it is not about making individual firms more stable, creating systemic security and enhancing economic growth. We must be mindful of the impact on the wider economy. Our forefathers made the mistake of not doing so in the 1930s – we must not repeat those mistakes.

“The cumulative impact of the enhancement of capital ratios - if applied at the wrong stage of the credit cycle - could drive a new credit crunch. Regulation needs to be properly co-ordinated and phased across a wide range of jurisdictions as green shoots slowly turn into a wider wide recovery.”

He criticises the argument that some banks have become too large and argues against regulation that could break them up. “All banks are too big to fail in a strict sense. But less diversification by geography and business line could lead to more, not less, failures. Calls to return to an earlier age of narrow banking misses the point that markets are now global with complex needs. It is highly inefficient to ask a business customer to use a range of institutions and would not reduce risk in the system.

He does, though, endorse ideas that promote systemic stability. “Inflation targets and interest rates policy are necessary but insufficient to fight global imbalances. We need additional tools to smooth the credit cycle such as counter-cyclical capital ratio management. In the good times, banks would increase capital they hold and build up reserves for leaner times. In leaner times, the capital ratio could be managed to offset the drop in lending.”

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Stephen Green: "no return to the past"

Tue, 24 Nov 2009 03:43:39 -0800

Stephen Green, chairman of HSBC Holdings, says the system has been abused and misused but it is not broken, and attempts to fundamentally change it are misguided.

“75 years after the Great Depression, people have come once again to despise our version of capitalism,” he says. “We need to act to be the architects of real and sustainable change.”

He points to where flaws emerged. “We had persuaded ourselves that the good times would roll forever. This misguided belief allowed consumption to grow faster than income. This led to bubbles and ephemeral trading in financial instruments that served no purposed in the end. Then there were the growing global imbalances, the cheap money following the dotcom bust and 9-11, combined with a markets efficiency hypothesis that price would always reflect value.”

But wholesale change is not available. “There is no turning back,” Mr Green says. “There is no alternative but to improve the system and move forwrad. We cannot turn the clock back to a simpler era when things were more controllable.”

He says some things have actually worked well in the financial system. “Much was right, not all was wrong. We must be careful not to throw the baby out with the bathwater.”

Securitisation is one example of this. “Some became too complex and opaque and people stopped asking the right questions. The need for reform is clear and some parts of the asset-backed world have gone for good. But at its best, it helps to allocate capital through the markets. Securitisation is a fundamental part of the financial system. It is as natural as the public debt markets.”

We need to ensure they operate effectively and transparently, but not to regulate them out of existence. We cannot reintermediate back onto the balance sheets of banks.”

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First ever conference on responsible asset management, says Clarke

Tue, 24 Nov 2009 03:27:40 -0800

Rupert Clarke, chief executive Hermes Fund managers, points out that today’s conference is historic. “We are all familiar with responsible investment, but this is the first conference that focuses on responsible asset management,” he says.

This, he explains, means applying governance and ethical criteria not just to quoted companies, but to the full range of assets and vehicles. It also means looking at how asset managers themselves operate. “It is an extension of responsible investment to cover all asset classes and to consider the role of the asset manager as a responsible custodian acting as a fiduciary for long-term investors.”

Transparency is central to this, he says. “Do long-term investors really know what their hedge fund is doing to achieve those 10 per cent annual returns,” he asks. Is the fund really hedging or is it just relying on a beta strategy that could come undone at any time? “Does the one -year high-watermark structure really work for everyone?”, he adds

Institutional investors have been on the receiving end of much criticism for failing to be responsible asset owners, and rightly so. “They were in a position to have avoided the worst excesses caused by the lack of risk frameworks and the existence of poor remuneration policies that increased risk,” Mr Clarke says.

“Investors await the final recommendations of the Walker Review later this week to learn of their fate. However, we perhaps might have been responsible enough to do much of this ourselves without waiting for regulation to come in. We may have left it too late now.”

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Lord Mayor says London must adapt

Tue, 24 Nov 2009 03:11:52 -0800

Alderman Nick Anstee, the Rt Hon Lord Mayor of the City of London, says investor trust has been lost over the past year and London needs to be at the forefront of efforts to restore it.

He says instruments such as CDOs have been instrumental in the erosion of trust. “They encouraged irresponsible lending on a massive scale and resulted in enormous short-term gains at the expense of loss of trust in the financial services industry.”

The response is now being driven by investors, he says, and the industry needs to respond. “Investors looking after pools of capital are demanding a better deal. A more enlightened approach is needed so trust can be rebuilt.”

London is key to this. “London has always been at the forefront of innovative investment and it will continue to lead with the drive to responsible asset management.”

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Welcome

Tue, 24 Nov 2009 02:10:07 -0800

A full house expected this morning, standing room only.

The Lord Mayor of the City of London is about to make his opening address, followed by Glyn Jones, chairman of Hermes Fund Managers. Top line up of speakers to discuss one of the most pressing - if not the most pressing - issues of the day: responsible fund management. Think failures of risk governance over the last year, think excessive bonuses, and you get the idea.

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About the conference

Mon, 23 Nov 2009 08:33:00 -0800

Meeting the Challenge of the New Financial World
The credit crunch has highlighted the need for institutional investors to promote a sustainable financial system and be more actively engaged with the assets they invest in. But given the limited resources most have in place, how can responsible asset management work in practice and what benefits does it really provide?

At this international one day conference, Hermes and the City of London Corporation will bring together senior representatives from pensions funds, fund managers and advisors to consider how best to align their interests and build a sustainable future for the global investment industry.

Session highlights will include:

• Key steps necessary to achieve effective responsible asset management

• Applying responsible investment and ownership in different asset classes

• Aligning interests through fund governance and the remuneration of fund managers

• Building strong financial markets and ensuring the right levels of regulation

Speakers include

Paul Tucker, Deputy Governor, Financial Stability, Bank of England
Stephen Green, Group Chairman, HSBC Holdings plc
Lord Myners, Financial Services Secretary, HM Treasury
Stuart Fraser, Chairman of the Policy & Resources Committee, City of London
Roderick Munsters, Chief Executive, Robeco
Antoine de Salins, Executive Director, Fonds de Réserve pour les Retraites
Liz Peace, Chief Executive, British Property Federation
David Blood, Senior Partner, Generation Investment Management
Peter Damgaard Jensen, Chief Executive, Pensionskassernes Administration A/S

The full conference programme can be seen here.

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