Is Institutional Investor Stewardship Still Elusive?
Northwestern University School of Law; London School of Economics
September 1, 2015
Butterworths Journal of International Banking and Financial Law, pp. 508-512, September 2015
Abstract:
This article examines, on the fifth anniversary of the landmark UK Stewardship Code, the notable achievements and continuing challenges in the drive to encourage institutional investors to be informed and engaged owners.
The key messages are:
- Getting institutional investors to be good owners has proved challenging, hampered in part by the failure of stewardship codes to tackle the root causes of poor shareholder stewardship.
- Promising developments in recent years have occurred principally at the asset owner level – particularly pension and sovereign wealth funds – rather than among the ranks of for-profit asset managers.
- Notably, some asset owners have lengthened their performance assessment and ownership timeframes, shrunk their portfolios, and contracted the chain of ownership. Meanwhile, some passive/index investment firms have begun embracing stewardship.
Note: This article is a follow up to “Why stewardship is proving elusive for institutional investors” (2010) and “How conflicts of interest thwart institutional investor stewardship” (2011).
Is Institutional Investor Stewardship Still Elusive? – Introduction
The idea that institutional investors should behave as active, long-term oriented “stewards” has caught on globally. Five years after the launch of the landmark UK Stewardship Code, counterparts can be found on four continents (see Figure 1).
When the UK code was promulgated, I argued in these pages and elsewhere that institutional investor stewardship was an elusive quest due to, inter alia:
- Inappropriate performance metrics and financial arrangements that promote trading and a short-term focus;
- Excessive portfolio diversification that makes monitoring of investee companies challenging;
- Lengthening chain of ownership that weakens an ownership mindset;
- Passive/index funds that pay scant attention to corporate governance; and
- Pervasive conflicts of interest among asset managers.
The fifth anniversary of the UK code provides an opportune moment to examine the notable achievements and continuing challenges in the drive to encourage institutional investors to be informed and engaged owners.
In a nutshell, progress has been mixed and achieving broad-based institutional investor stewardship remains elusive. Promising developments have occurred largely at the asset owner level – particularly pension and sovereign wealth funds – rather than among the ranks of for-profit investment firms (“asset managers”) that invest the funds of asset owners.
To help spur improvements in investor behaviour, this article will highlight areas where substantive changes have taken place or are underway but readers should be under no illusion about success overall. Meaningful progress has proved hard to come by, hampered in part by the failure of stewardship codes to tackle head on the ailments highlighted above.
The Achilles Heel Of Stewardship Codes
Stewardship codes are laudable initiatives but most suffer from a critical deficiency: They are largely devoid of substance.
The UK Stewardship Code, for example, has generally failed to address the root causes of poor shareholder stewardship, opting instead to focus on process and mechanics (see Figure 2).
It is lamentable, therefore, that the UK Stewardship Code has served as a template – replicated almost verbatim in some cases – for counterpart guidance in such countries as Italy, Japan, and Malaysia.
The superficiality of stewardship codes extends to the misguided pursuit of as many signatories as possible. In the UK, code signatories now exceed 300, including approximately 200 asset managers. In Japan, where UK-style company-shareholder engagement is still relatively unfamiliar, nearly 200 institutional investors signed on in the first year of the stewardship code’s existence. While the high levels of take up make for good headlines, the crucial question is whether signatories have truly embraced stewardship.
The evidence accumulated in the UK suggests that the answer is clearly “no”. In its 2014 report on corporate governance and stewardship developments in the UK, the Financial Reporting Council sounded an alarm that “too many signatories fail to follow through on their commitment to the code”.
According to the head of corporate governance at a UK investment institution, “Of the roughly 300 members of the stewardship code, I would say there are only about 30 institutions that are doing the job properly.”
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