Pension funds tackle short-termism

By Colin Melvin
Chief executive, Hermes Equity Ownership Services

The job of a pension fund trustee has become more complex than before

The boss of one of the world's largest stewards of pension fund assets, HEOS, representing shareholdings worth over £50bn, warns on company short-termism.

"Company boards across Britain and in particular those of banks are expected to face their toughest AGMs on record as the proxy voting season gets under way.

In the past 12 months equity values have fallen through the floor, wiping millions of pounds from company valuations.

Amongst the biggest casualties are the institutional investors, such as pension funds who own these companies, which hold the lifetime savings of millions of ordinary people.

Some of the world's biggest pension funds have started to join forces, with the aim of using their combined might to bring about lasting change to the way companies operate

Many of these people will now be forced to work beyond their intended retirement age to make up the shortfalls in their pensions, having had their hopes raised and dashed as successive rescue plans failed to restore market confidence.

Yes, there has been the occasional dramatic AGM over the years.

But by and large, pension funds have left relationships with their portfolio companies to their investment managers.

They have witnessed risky merger and acquisition decisions, excessive and misaligned executive remuneration, and powerful executives clinging to the dual roles of chairman and chief executive.

They have also seen poor risk-management, short-term business strategies and off-balance sheet accounting representing a ticking time bomb of toxicity.

'Complex'

However, there are some glimmers of hope.

Some of the world's biggest pension funds have started to join forces, with the aim of using their combined might to bring about lasting change to the way companies operate.

Powerfully motivated by the colossal losses suffered by pension funds, this growing group of heavyweight investors are starting to create a very different investment environment, in which they recognise and implement their roles as company owners through their shareholdings.

We are unlikely to restore confidence and trust in banks simply through their recapitalisation in publicly funded bailout packages

The job of a pension fund trustee has become more complex now than ever before, as many of them are part-time and sometimes from non-financial backgrounds.

Support, through a formal collaboration and shared specialist expertise, is enabling trustees to navigate through the complexities of the global business, financial and regulatory environment.

They are concerned to ensure that the credit crisis leads regulators to promote open, fair and transparent markets to facilitate enterprise in the long term.

Armed with the knowledge that the key to the restoration of stability lies within themselves, pension funds are becoming a growing force for change.

We are unlikely to restore confidence and trust in banks simply through their recapitalisation in publicly funded bailout packages.

'Sensitive issues'

A clear task for government is to encourage pension funds and other long term investors to be better, and more involved, company owners.

It is for these end owners to work with the companies they are investing in - to enhance their value to their own benefit, and to the benefit of us all.

By acting as a united voice, pension funds are helping to steer companies away from dangerous waters towards the safer shores offered by more accountable, transparent and responsible business practices.

President Obama has promised an era of 'responsibility'

As investors the job of tackling company boards on sensitive issues such as social, ethical, environmental and governance is a tough one.

Last year HEOS engaged with hundreds companies internationally, on behalf of some of the world's biggest pension funds, to ensure that the companies its clients invest in are behaving in the long-term interests of shareholders.

It is in the US that institutional investors face their toughest challenge, as shareholder rights there are amongst the poorest in the world.

Institutional investors are looking to President Obama to deliver on the promise he made when he came to power, which was to usher in "a new era of responsibility."

Taxpayers have had to shoulder the risky decisions made by businesses on three counts; they've not only had to pick up the bill through their retirement funds, but as tax payers, and also - painfully - as employees facing reduced prospects and large scale job losses.

'Catasrophic'

It cannot be good for sentiment and confidence in the US economy to witness companies consuming successive rescue packages.

Over 70% of the US's largest corporations are owned by institutional investors.

A more sustainable route for the government would be to empower and encourage the owners of those companies such as pension funds, by strengthening shareholder rights, to enable them to be better and more involved owners, and work with the companies they are investing in to enhance their value.

Way before the credit crunch happened many pension funds had already begun to spot the damage being done to the companies in which they invested by endemic City short-termism.

Refusing to be dazzled by a self-fulfilling boom in prices and transactions, they started to provide the companies they invested in with the challenge and support of a good owner.

In their view companies whose time horizons did not extend beyond the next quarter would struggle to become sustainable engines of economic growth.

The impact of short term behaviour, such as risky lending practices, has proven to be catastrophic for the businesses involved and has undermined the entire financial system.

Whilst I applaud the decision by the G20 to adopt an intergovernmental supervisory approach rather than add another layer of regulation, it is too early to know whether the initiatives announced will make a difference and restore confidence.

I am however, certain that it is impossible to solve a global problem through government action alone, we must engage business and connect companies with their owners.

'Silver lining'

As we look ahead to the Walker Report on corporate governance in the financial services sector, I hope that it tackles the root cause of the problem, which is a change of culture and promotes more accountable business practices, which are critical in the restoration of trust and stability.

The more progressive pension funds which are starting to engage in this new model of dialogue are reporting a myriad of benefits from the opportunities to influence, structure, direction and the management of the businesses they jointly own.

Boards of directors are also seeing the many benefits from a supportive dialogue with institutional investors who take a longer-term perspective.

Most companies are relieved to find that someone in their shareholder base is taking an interest beyond the short term numbers.

The financial crisis has shown the damage that bad corporate governance and ownership can do and companies are becoming receptive to an intervention which promotes long term growth and value.

If there is a silver lining around the cloud of the global financial meltdown, then it is that the crisis has shone a bright light on the risks and dangers of short-termism, which in turn is leading to a growing force of converts towards a more responsible approach to investment and company ownership."