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Developments in responsible investment

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Within a short space of time shareholder activism appears to have turned from being an activity understood by few and undertaken by even less into something at the heart of investment management.

Fund management organizations which in very recent history would have prided themselves on their close 'don’t rock the boat' relationships with investee companies now seek to demonstrate that they will take a tough line where it is necessary to do so.

Trades unions too have sought to enter this new sphere of activism. In the US the AFL-CIO and its affiliates are active in dozens of shareholder campaigns and corporate governance actions each year. In the UK we too have made some small steps forward and made limited interventions, particularly on executive pay.

This paper reviews the recent development of activism in the UK.

What is shareholder activism?

Anthony Bolton, the Fidelity fund manager widely regarded as being the driver behind Michael Green’s forced exit from ITV, no doubt has a different view of shareholder activism to that of the TUC. But there is probably a basic core definition that most would agree on -­ the exercise of ownership.

The differences in interpretation occur when we look at, first, the aims of activism and, second, the means of activism. A mainstream fund manager would no doubt argue that the aim of activism is to increase (or protect) returns to shareholders. Whilst unions would certainly seek to ensure returns are generated and enhanced they will also look to improve standards of corporate governance and social responsibility.

Equally when we look at the means deployed in the service of activism, whilst there is a great deal of interest in the use of voting rights as an activism tool, many interested parties would probably argue that other elements of the relationship between shareholder and company are equally, if not more, important.

The picture is confused still further with socially responsible investment (SRI), which is often used interchangeably with shareholder activism. However, whilst all socially responsible investors are shareholder activists, it is not true to say all shareholder activists are socially responsible. As such it is easiest to consider SRI as a subset of shareholder activism. SRI attempts to use shareholder activism as a means of delivering both financial and social benefits.

A review of the recent history of SRI

SRI has had a difficult birth in the UK. The first ethical funds were both lampooned and criticized by most in the fund management industry, and apparently even struggled to be registered because of concerns that they were not trying to make money. Only a few years ago the National Association of Pension Funds wrote to the government warning that the proposed amendment to the Pensions Act requiring pension funds to disclose their policy on socially responsible investment would make trustees the target of extremist pressure groups.

Since then we have come a long way. Significantly the language has changed dramatically - ‘ethical investment’ became ‘socially responsible investment’, and now often simply ‘responsible investment’ or ‘active ownership’. Many fund managers now offer retail SRI funds and a small number of pension funds, particularly in the public sector, are trying to put responsible investment into practice in a significant way.

The practice of responsible investment has also undergone a significant transformation as screening has given way to engagement. There will no doubt continue to be demand for screened funds. Individual retail investors often have strong moral or political views and it makes sense that they should be able to reflect these in their choice of investments as they can with other product choices. There will also be some institutional demand. It seems likely for example that churches and charities will continue to opt for the screened approach.

But as responsible investing has sought to become mainstream the approach most favoured has been engagement where there is no constraint on the portfolio. The dominance of engagement has reached the stage where it has now entered the parlance of the mainstream fund managers, particularly as a way to explain why their activism should not be judged on their record of exercising voting rights. In addition responsible investing is now largely argued on financial as opposed to moral grounds, with the argument being that responsible companies are more likely to perform well.

Yet, despite these policy and product developments, responsible investment has still not taken off in the way many had expected, particularly amongst pension funds. Specific SRI mandates are almost non-existent outside the public sector. Most private sector pension schemes do little more than delegate responsibility to their fund managers who in turn claim to take SEE issues into account in the investment process but it seems in reality do little.

Why has responsible investment failed to grow?

To understand this lack of progress it is worth examining what factors have stunted the growth of responsible investment. To begin with we should consider why it remains such a controversial idea to the pensions industry. This is no doubt in part because it provides a fundamental level it represents a challenge to commonly-held ideas about what drives shareholder value.

It does this in two ways that are closely linked. First, it suggests that mainstream financial analysis has failed to pick up on the importance of issues such as human capital management, environmental management and adherence to widely-shared standards of corporate behaviour in company performance. Outside of the few fund management firms that have taken responsible investment seriously the skills to analyse companies on these issues and factor this analysis into investment decision-making do not exist.

And going further investment consulting firms have not developed much capacity to judge the competency of fund managers in this area. This has seemingly resulted, on one occasion, in a manager with no demonstrable track record in or commitment to responsible investment winning an SRI mandate.

Secondly, increasingly responsible investment challenges the length of time over which the creation of shareholder value is judged. The Myners review highlighted some of the problems with focusing on short-term relative returns, but it was the activist Universities Superannuation Scheme that really kicked off the debate in the UK about how to invest over the long term. There is evidence that activity that boosts share price in the short-term actually destroys shareholder value in the longer run, one only has to look at the performance of companies post-merger to see this. And since pension funds are long-term investors surely the really ought to focus on what delivers value in line with their time horizons?

But again the skills for operating a long-term investment approach are in short supply amongst both managers and consultants. It is a new concept for most pension funds. The entire industry is currently geared towards short-term performance and performance measurement. So overall the infrastructure required for responsible investment to be a central part of pension fund asset management is patchy to say the least.

Beyond the questions about shareholder value, another barrier to the adoption of SRI is uncertainty about the benefits - particularly financial - of adopting a responsible investment strategy. A recent survey of pension fund trustees [1] carried out as part of the Just Pensions project found that this was the most common reason why trustees had not done more, with 33% of respondents saying it was of great significance.

The final factor at play is cultural - the concern that remains in some quarters that responsible investment represents an attempt to politicize fund management. This view sees SRI as driven by 'NGOs in suits' with their own agenda rather than the desire to generate the returns necessary to pay pensions. We should never underestimate the conservatism that is prevalent within the pensions industry.

The unfortunate reality is that these pressures reinforce each other and create a vicious circle. Because of conservatism about responsible investment there has been little client demand. Because there has been little client demand most fund managers have not built competence in this area. Because most managers have not built competence most consultants have not sought to assess managers on their competence in responsible investment. Because consultants do not have much knowledge of how to implement responsible investment strategies they are unlikely to be proactive in suggesting them to trustees. And because professional advisers do not proactively advocate responsible investment strategies lay trustees are uneasy with the concept and do not seek to raise the issue themselves.

Why is this unique to SRI?

The failure of SRI to develop as an investment strategy for pension funds is in stark contrast to other approaches. For example for many involved in pension fund investment the jury is still out on active management. The case for has not been conclusively proven and as a result we have seen a huge growth in the weight of assets managed passively. Many funds now employ an index-tracker at least for a core of their portfolio.

Yet most funds continue to employ active managers at least as ‘satellites’ to a passive ‘core’ because they believe they may be able to capture outperformance. At the risk of being provocative this means trustees are effectively paying a significant premium for a service based on a hypothesis that has often been proven wrong. However they are still willing to make the leap of faith. This point has been articulated well by Peter Moon, the chief investment officer of the Universities Superannuation scheme:

' The debate about active versus passive investing - hundreds of papers which contradict each other - should be a warning for those who look for proof! But the absence of a definitive answer on active versus passive investing - rightly - does not paralyse trustee decision-making and similarly, by the time we have a large body of evidence for and against SRI, it may be that there is neither value to be arbitraged or a society or environment that we want to retire into.' [2]

To take the point further currently pension schemes are being encouraged by consultants to put a significant slice of their assets into hedge funds, the industry’s latest promise of investment alchemy. There is a limited track record to judge these funds on, there are concerns about the risks being taken and hedge fund fees are much higher than those for normal active management. Yet despite all this consultants are actively promoting them as an investment option and many fund managers have set up hedge funds to serve the institutional market. The contrast with SRI could not be more striking.

One can make a similar point about the reluctance of many fund managers to take CSR issues seriously. A good comparator here is the corporate governance Combined Code. Although there is an emerging consensus that there is a correlation between corporate governance and performance it is probably a fair statement that the evidence is not yet conclusive. The most positive statement most governance experts are willing to make is that companies with poor governance are more likely to underperform those with high standards. Yet despite the lack of hard evidence proving that adherence to the Combined Code delivers value to shareholders it is (to a greater or lesser degree) supported and promoted by UK institutional investors.

More specifically it appears that in the UK the tone of the debate on executive remuneration is changing. Whereas in the past, despite public anger at the continually rocketing salaries of executives, the line taken by most fund managers has been that the only issue of concern is the link to performance. The debate was effectively tagged back to so-called rewards for failure. However more recently we have seen an emerging argument that it is time that levels of pay should also be debated, particularly relative levels of pay throughout companies. Some fund managers’ corporate governance policies are now quite specific on this point. Yet there is no widely accepted evidence that pay differentials have any impact on share price performance.

Unlike proponents of responsible investment, corporate governance advocates are increasingly rarely challenged to demonstrate that there is a clear link between their activity and share price. Or to reverse the proposition corporate governance activists are not accused of interfering with the fiduciary duties of trustees by advocating activism in the way that responsible investors often still are. Rather governance activism is seen as something that is a good way to both minimize risks and promote higher standards.

Fund management and the creation of shareholder value

It is perhaps understandable that there is some inertia. Trustees who are worried about their fiduciary duty, and will almost certainly face more pressing problems in the shape of scheme funding, may question why things need to change. Embracing responsible investment can look like a radical change to the way things are done with little evidence to back it up. The present approach to pension fund investment at least looks logical and seems to work.

So at this stage it is useful to consider how fund managers operate at present, and the notion of shareholder value creation. Although both areas might appear to involve hard-edged, efficient, logic-driven decisions, closer inspection reveals that both the thinking and practice in relation to both are often more simplistic than might be first expected.

Looking first at fund management, despite an entirely different formal explanation, and the employment of huge teams of both buy-side and sell-side analysts, it seems that fund managers often continue to work on hunches. As one leading fund manager is quoted as saying:

'There are no rules; I like to kiss and cuddle the numbers. I try to be pragmatic and hope that, from a framework of knowledge and hard work, I can make some sensible decisions. But I can’t tell you how I do it.' [3]

Sometimes the business of generating returns is still more about making ‘bets’ on the relative movements of share prices than investing due to real conviction about the quality of investee businesses. This is particularly true of many hedge funds which often aim to make money by taking advantage of short-term inefficiencies in the market, or by following the momentum of trading.

As controversial as this might sound one need only look at the recent technology, media and telecom (TMT) stock bubble for confirmation. Despite widespread misgivings about what was driving soaring prices of hi-tech firms many large institutional investors continued to be exposed to them.

There are two possible explanations for this. The first is that normally incredulous fund managers over a short space of time became convinced that the ‘new economy’ really had torn up the rulebook and that previous methods for analysing and valuing companies were redundant. If this is the case then we witnessed a significant collapse in the ability of fund managers to sort the wheat from the chaff. They were no more skilled at investment decision-making than the thousands of individual punters looking to make a quick return from companies about which they knew little.

The alternative interpretation is that fund managers knew that the TMT stock boom was built on extremely weak foundations not justified by proper analysis and was developing as a bubble. But because of the need to generate returns that were at least in line with those of rival investment managers they were obliged to remain invested in these companies.

It is not an encouraging choice. Either fund managers lacked the very skills for which they are extremely well-rewarded or they are so constrained by the way the fund management market operates that they felt compelled to invest in companies in which they had no faith. And either way the net result was the continuation and reinforcement of a huge bubble and a massive misallocation of workers’ capital.

In fact some fund managers will admit these days that they had concerns that a bubble had developed. But for commercial reasons they were locked into game of chicken, unable to divest because in the short-term that might reduce their performance relative to rivals. This process has been clearly explained by Chris Cheetham, then chief investment officer of Axa Investment Managers.

'When Vodafone acquired Mannesman, many investment managers took the view that it made sense to increase their holding even though they believed the shares to be expensive and likely, eventually, to fall in value. The same managers became ever more likely to invest in TMT stocks the more expensive they became. Why? Because to be underweight in these investments without the certainty of being proved right, created significant business risks if the impact on short-term relative performance was serious and if the Principal took a dim view of the way his funds were being managed. Failing conventionally when managing a portfolio can sometimes lead to an acceptable outcome for an investment manager’s business.' [4]

It is clear that the type of behaviour outlined was indeed ruthlessly reinforced by the pensions industry. Famously Tony Dye of PDFM took a bearish view on the level of the market. But the correction did not come as early as he had expected and the manager performed poorly compared to its peer group. Pension fund clients rewarded PDFM for sticking to its guns by dropping the fund manager from mandate after mandate. Of course one can legitimately argue that Dye was ‘wrong’ rather than ‘right’ because he called the correction too early. However an important message to draw from this is that in the pensions industry there is often no premium for following your principles, and indeed it can be commercial suicide.

Again this point is reaffirmed by fund managers themselves.

'If an investment manager has model certainty (a hard thing to achieve) and the courage to be independent... does he/she have the time to be proven correct? Moreover, is it good for business? What is the pay-off? Will both clients and the asset manager’s shareholders remain supportive?… There is tremendous pressure and incentive, because the potential rewards are significant, to find ways of generating good performance in the short term.' [5]

'External pension fund managers, unit trust and unit-linked managers are under constant and intense pressure to maximize current performance. The current quarter is what matters, perhaps the next quarter, certainly not next year’s equivalent quarter. Confronted with the prospect of an uplift in the value of his portfolio from a bid, or a decline in performance as a company reports a short-term blip in an upward trend, the gut reaction of a professional fund manager will be to go for whatever enhances or protects his current performance figures.' [6]

If anything the pressure on fund managers for short-term performance is likely to increase with the widespread shift to defined contribution (DC) pension provision amongst companies. In a defined benefit (DB) scheme the trustees can, in theory at least, seek to look at performance over the longer term. Because most such schemes will be in existence for many decades to come, until the last beneficiary has died, investment strategy can be set with a longer-term perspective. Most importantly for the individual performance is not an issue as the sponsor shoulders the risk.

In contrast in a DC scheme the member bears all the investment risk. Poor returns inevitably result in smaller pensions. In addition the time horizon is the individual’s working life. They may not feel they have time to wait for poor performance to turn around and hence may be more inclined than a trustee to fire a poorly-performing fund manager. In addition it seems certain that demand for certain alternative asset classes will be affected [7] .

The obsession with performance is already even more marked in the retail fund management sector than its institutional counterpart. Much DC marketing makes a big point of the ability of members to change their investments regularly. This surely points to and even greater focus on short-term figures in future and in turn more churning amongst fund managers. This in turn must encourage fund managers to think short term.

As a final word on the vagaries of traditional fund management it is worth considering the development of behavioural finance as an area of interest in both the investment management and consulting industries. Put simply behavioural finance seeks to understand the psychological factors that are at play in investment decision-making. But clearly even considering that non-rational factors may affect the decisions of fund managers undercuts confidence that active management can be seen as a logical approach to allocation of capital.

Again this links back to the misallocation of capital that occurred during the TMT bubble. Another interest essay on the development of the bubble postulates a theory of how fund managers’ decision-making became distorted when faced with the need to react to rocketing tech stocks. It argues that fund managers effectively reduced their focus on actual investee companies, and instead shifted it onto their rivals, compounding the deterioration in decision-making. [8]

So if the business of fund management is an imperfect, imprecise one that can create lead to value destructive behaviour, what about the overall focus on shareholder value?

The failings of shareholder value

The focus of the shareholder value ‘movement’ was to properly align the interests of businesses and their owners, the shareholders. It in part grew out of a view that many businesses were being run inefficiently and that this was leading to poor returns to shareholders.

The movement, such as it was, has had noticeable impact. Companies are far more attuned to the views of shareholders, institutional investors in particular, than they were. They frequently cite radical restructuring and other moves as being driven by the desire to create shareholder value, and companies also feel they are under significant time constraints to turn problems around, or at least attempt to do so. Many would argue this has brought greater discipline to listed companies.

In addition, much of the change in executive remuneration policies can be attributed to attempting to align management and shareholders. The development of share options as an element of remuneration is an obvious example.

But as John Plender has pointed out by focusing on one indicator of performance -the share price -­ directors are encouraged to undertake activity that manipulates that indicator, sometimes regardless of the impact this has on the business.

'The bizarre irony here is that the shareholder value movement has ended up replicating the errors of socialist planners in the old Soviet Union who imposed targets on industrial managers that were frequently met by fiddling the figures or doing damage to some other aspect of the business. By fixing on a single managerial incentive - the share price - the Anglo-American system has encouraged management to maximize short-term profits at the expense of longer term growth. When managers found that they could not generate enough short-term profit to satisfy investors and stock market analysts in the bubble period, they resorted to takeovers as a means of keeping one step ahead of the baying hounds of the financial community. And when takeovers became more difficult to pull off in the depressed stock market conditions that followed the bubble, they took to window-dressing the figures either within the rules or fraudulently as at WorldCom. [9] '

As a senior figure in the fund management industry has commented the one thing you are sure to find on a chief executive’s desk is a screen tracking the company’s share price. Although arguably this may be a useful discipline for senior executives, equally it may focus them on the wrong measure and the wrong timescale.

It is noticeable also that executives seem to draw a much stronger causal link between their actions and movements in share price than many investors do. It is clear that share prices are driven by a wide range of factors, even psychological ones, and many fund managers are wary of attributing movements to one specific element. But senior executives often seem to have a much narrower interpretation of shareholder value creation, and one which sees just a few levers that can be pulled to affect share price.

The shareholder value movement may have worked as a discipline for company management, but it appears that this may now have given way to a simplistic and reductionist view of what shareholder value is and how, and over what timescale, it is created.

An interesting critique of the results of this approach is provided by Don Young and Pat Scott, two former directors of Redland Plc, in their book Having Their Cake [10] . In it they describe how the company’s management gradually became more fixated on pleasing the capital markets than on what was actually good for the business in the long term. Greater importance was placed on knowledge of corporate finance than operating knowledge of the various businesses in the group. The result was a series of acquisitions that pleased analysts at the time but ultimately failed to deliver. Undoubtedly the same story could be told about many other UK companies in recent years.

Changes in beliefs

But are these increasingly accepted criticisms of the way the system operates at present leading to any reappraisal of how things are done? Actually it does appear that the bubble and subsequent correction have caused some in fund management and investment consulting to fundamentally look again at what they do. A paper produced by Watson Wyatt at the end of 2003 revealed a surprising degree of soul-searching about the beliefs (as opposed to knowledge) that underlie the way pension funds invest.

' In investment you are confronted with assuming either a theoretical world of ‘perfect’ (complete) information or the (not unreasonable) assumption that the future is ‘unknowable’. In both cases beliefs are vital. In the first, we use beliefs as short-cuts in our decision-making saving large amounts of computational time…. In the second case, with so much of the puzzle missing (concerning how the future will unfold) beliefs are needed to fill in the gaps; beliefs here are necessary to achieve any sort of quality attempt to add value through more accurate assessment of the future. ….we would assert that all investment advice is based on underlying beliefs, whether recognised or not.' [11]

For trustees who have become used to assuming that their professional advisers are in possession of the ‘correct’ technical answers to questions of funding, or investment, such philosophical views from may come as something of a shock.

Looking more widely there is in some quarters an emerging conception of shareholder responsibility. This way of thinking asserts that in addition to rights shareholders also have duties towards the companies they own. Exactly what these duties are is a matter of debate but bodies including the International Corporate Governance Network [12] , the Institutional Shareholders Committee [13] and the OECD [14] have all attempted to define some key themes. Common to them are the need for shareholders to address issues of concern in investee companies. This typically seems to concern corporate governance but also includes CSR factors.

Why institutional investors are suddenly switching on to the idea of shareholder responsibilities is a moot point. In the UK it appears that it largely a response to political pressure. Taken together initiatives such as the July 2000 amendment to the Pensions Act, the Myners review and the introduction of an advisory vote on executive pay policies add up to clear desire on the part of the government for a more activist investment culture.

In assessing the impact of the Myners principles the Government has appeared unimpressed on the subject of shareholder activism, thought largely in relation to pension schemes’ failure to act [15] . The smarter fund managers have no doubt recognized this and as such sought to jump before they were pushed. And certainly some of the more activist fund managers have indicated that they are quite some way ahead of client demand.

Influencing the direction of pension fund investment

Taken together these factors suggest that there is something of a window of opportunity to influence the way that pension fund investment develops over the coming years. The example of the Universities Superannuation Scheme demonstrates that pension funds which are committed to activist and responsible investing (and are sufficiently large to matter) can use their position as a client to influence service providers, and even to broaden the investment debate.

It is really no more complicated than that responsible investing will only become mainstream if clients (ie trustees) start to demand it. For those of us that want pension funds to refocus on long-term shareholder value and responsible ownership this is where we need to direct our energies.

In the trade union movement we have some capacity to act. By law pension funds must have member-nominated trustees (MNTs), and a significant number of MNTs are union members or officials. The TUC maintains a network of 1,000 MNTs and we now send them regular information on investment issues including responsible investment, and hold trustees events that promote the idea of activist investing. The TUC also produces a survey of how fund managers exercise shareholder voting rights.

But there are other areas that are as yet untapped. Mergers and acquisitions are a key area of interest and concern for trade unions because of the threat to jobs that often follows. M&A activity is frequently justified by management on the grounds that it will deliver value to shareholders. This is often true ­ in the very short-term. But various reviews of the evidence demonstrate that whilst share price is boosted at the time this does not last and in fact many mergers destroy value in the long term. A notable example of this was a study by KPMG produced in 1999.

'The survey found that 82% of respondents believed the major deal they had been involved in had been a success... When we measured each one against our independent benchmark, based on comparative share performance one year after deal completion, the result was almost a mirror opposite. We found that only 17% of deals had added value to the combined company, 30% produced no discernible difference, and as many as 53% actually destroyed value. In other words, 83% of mergers were unsuccessful in producing any business benefit as regards shareholder value.' [16]

It should be noted that a subsequent KPMG study issued in 2002 reported better figures, but still only 34% of deals created value for the acquirer’s shareholders.

This is an extremely powerful argument for unions. Not only are mergers often bad news for working people as employees within companies ­ they are also bad news for them as investors. Unions can therefore quite legitimately query mergers on the basis that they will destroy shareholder value. And trade union trustees arguably have a fiduciary duty to push fund managers hard on the case for individual mergers.

This is not as radical a suggestion as it might sound. The recent Tomorrow’s Company report into investment suggested both that non-executive directors should obtain independent advice on proposed bids and mergers, and that companies should commission an independent audit of past acquisitions. [17]

But where are the unions?

Despite these opportunities, in the UK trade union involvement in shareholder activism has to date been limited. On the one hand this is a missed opportunity. Unions could be pushing the shareholder case for high performance workplaces, proper health and safety management and equal rights, and using their position as investors to back this up.

On the other hand it is arguably also inadvertently undermining unions’ work elsewhere. By not being properly engaged in debates on shareholder value we are allowing the idea of what really is in shareholders’ interests to be defined in very limited financial terms by organisations that have little time for unions and are unaccountable to beneficiaries.

There is also an ongoing language problem. The starting point of the workers’ capital movement that it is workers themselves who now own corporations is basically correct. Clearly this ownership is diffuse, takes a very different form to ownership as espoused in the historical projects of the Left, and the rights of ownership bestowed on beneficiaries are, with limited exceptions, delegated to investment managers. But it is incontestable that working people are the ultimate beneficiaries of most share-ownership in the UK, and even when ownership rights are delegated this is done with formal aim of enhancing returns for the ultimate beneficiaries.

Despite this unions often seem incapable of kicking the habit of speaking of ‘shareholders’ as some mysterious third party intent on squeezing everything out of companies regardless of the impact on employees. This matters. Each time unions talk of ‘greedy shareholders’ we demonstrate an inability, if not unwillingness, to engage with the true nature of the capital markets.

A trade union movement that was properly engaged with the realities of institutional investment could contribute a great deal to the development of real long-term shareholder value based on companies that respect their stakeholders. We can even capture and redefine the term shareholder value as an expression of long-term and sustainable employment and wealth generation.

If instead we continue to talk about ‘shareholder greed’ we may find ourselves excluded from an important element of the debates about both the nature of companies and their governance, and the deployment of billions of pounds of capital.

It is certainly true that others will seek to use the opportunities offered by shareholder activism and engagement. For example, it is striking just how far NGOs appear to have penetrated the City. A quick look at the corporate governance and SRI teams at some of the leading fund managers shows that a not insignificant number of analysts, and even more senior staff, have an NGO background.

It is still an open question how much influence these teams have both within their organisation and with investee companies. However there are two points to note. The first is that campaigners see shareholder activism as having sufficient potential to work within an organisation that many NGOs might see as part of the problem. Indeed one ex-NGO staffer commented to the TUC that shareholder activism is 'the only game in town'. The second is that fund management organisations themselves see, at least for now, some value in employing people with this type of background.

Of course trade unionists share many of the values expressed by NGOs, and we should welcome the fact that they have been able to have an impact in SRI. In addition to bringing about some positive changes they have also set an example for how unions can follow suit. However it should also be noted that because it is principally NGOs that have driven the SRI agenda to date, whilst unions have largely been absent, there is a much stronger emphasis within the SRI community on environmental and other factors than on labour issues.

In addition one of the principal reasons why debates around corporate governance, investor activism and even shareholder value are dominated by traditional organisations is precisely because in general unions have not chosen to challenge them. For example the reason why it had been a commonly-held view in corporate governance circles that relative levels of pay are unimportant is because that was the position of the main shareholder bodies.

Unions seek to affect corporate behaviour at every other level of their interaction with companies. Yet at the level of ownership ­- surely one of the most influential - trade unions have too often been silent.

Even if one does not take this argument further to the conclusion that unions and union trustees specifically do not employ fund managers whose corporate governance and social responsibility policies do not meet approval it is surprising that so little is done to encourage service providers to meet union requirements.

There isn’t always a business case

It is necessary to provide a few words of caution. Whilst reclaiming and redefining the idea of shareholder value is a useful consideration, unions should be wary of painting themselves into a corner. As the concept of corporate social responsibility has evolved increasingly NGOs have sought to demonstrate that 'doing the right thing' is good for business.

Where CSR blurs into SRI this has meant seeking to demonstrate that there is a business case that will yield positive results for shareholders in companies adopting a certain type of behaviour. This trend is certainly welcome and, where links can genuinely be demonstrated, this can be a powerful argument for change.

However often arguments are still put in a rather basic way. For example reputational risk is often cited as an example of why companies should adhere to decent standards of behaviour. If companies damage their reputation through irresponsible behaviour then, the case is made, this can feed through to impact on sales an ultimately even the share price.

Reputational risk is clearly important. Brands and company image can become infected. But many listed companies are not customer-facing. A good example is Unocal which is one of the companies that continues to operate in Burma despite widespread pressure, including from some of its largest investors, to disinvest. Put simply the company apparently does not believe that the reputational damage of doing business with the Burmese regime outweighs the financial benefits.

Similarly one has to consider the scale of impact of a particular form of irresponsible behaviour on the company and whether this is genuinely financially significant to shareholders. One activist fund manager has commented to the TUC that for a CSR issue to really be ‘material’ to a large listed company it would need to be a risk valued in the billions of pounds.

The bottom line is that although there are some issues where there may be a strong correlation between irresponsible behaviour and poor share price performance there may be others where there is no strong link. There may even be examples where poor behaviour correlates with good performance.

The point is not to argue that the business case should never be made, but rather to draw attention to its limitations as a tool. Unions should not be pegged back to advocating, as owners, that a company adhere to certain types of behaviour only where there is a demonstrable business case. Just because in the short-term there is not a clear shareholder case for, for example, equal pay does not that mean that unions as investors should not push the issue with investee companies.

Unions should remain realistic about the effects shareholder activism can have. At the risk of being churlish one has to ponder whether Digby Jones’ belief in shareholder activism as a means of policing executive remuneration may demonstrate that such activism does not currently pose a serious challenge to company directors. However this actually demonstrates the need to be more involved in activism, rather than allowing it to be delegated to the City.

Some activist investors themselves are cautious about the influence they can realistically wield.

'Shareholder resolutions are [not], in anyway, a substitute for effective government regulation. Social investors and other activists can … [nip] at the heels of … companies ….[but corporations must be] subject to democratic control, regulation if you want.' [18]

But again the point is not at all to discourage unions from using activism of this form. Rather it needs to be seen as an additional and complimentary method of campaigning to be used alongside others. The experience of trade unions in the United States has demonstrated that approaching shareholder activism in this way is most likely to bring success.

The future pressure points

Finally, having reviewed past developments and obstacles to the further growth of responsible investing in the UK, it may be useful to sketch out some of the possible points at which unions could best exert pressure.

Most simply the point needs to be stressed that trade union members who are pension fund trustees could assert themselves much more. They are in an extremely influential position as the clients of fund managers but at present most managers report they feel little pressure from trustees to be effective owners.

The TUC and its affiliates now regularly provide trustees with training that stresses the importance of activism and suggests ways of becoming active on the trustee board. The general lack of movement so far suggests that far more training, particularly with a practical focus, needs to be carried out. Hence trustee training must be a cornerstone of any workers’ capital activity in the UK.

Thought should also be given to seizing the opportunities offered by the debate over long-term investment. Unions often complain that the focus of business is unduly short-termist. There is evidence to suggest that this focus is encouraged by institutional shareholders who in turn claim to be put under short-term pressure by pension fund trustees. By becoming more involved in this debate unions could help sketch out how to encourage trustees to think more long-term and hopefully by extension reduce the pressures inadvertently passed onto investee companies.

Should unions be feeding information into investment analysis? This is an important question as it implies that we accept that equity markets are relatively efficient and do respond to relevant information rationally. The Enhanced Analytics Initiative (EAI) [19] seeks to incentive sell-side analysts to carry out research on extra-financial issues such as environmental management. Unions could both support the EAI and carry out their own work to ensure that human capital issues are taken seriously by analysts.

It may have challenges. If analysts do begin to look at human capital issues and conclude that they have little material impact on shareholder value then other avenues would need to be explored. But such an initiative would at least signal a ratcheting-up of union intervention in the capital markets.

Finally the debate over the disclosure of voting records by fund managers now appears to swing in the favour of the position advocated by unions. Through the exertion of a little more political pressure the TUC believes this goal achievable. This would be an important strategic victory and demonstrate that unions have really 'arrived' in the field of shareholder activism (since it has been almost solely trade unions that have advanced the argument for disclosure).


Shareholder activism is still at a very early stage in the UK. Despite protestations from some organisations which would rather avoid any further government intervention that investor activism is widespread and well-rooted it is actually embryonic. In addition, progress on encouraging more pension funds to develop responsible investment strategies has been extremely limited.

There are opportunities to regain the initiative but at the same time there are several factors in the structure of institutional investment that mitigate against the development of activism. These include conflicts of interest and inherent conservatism on the part of fund managers, but also lack of demand on the part of pension scheme trustees.

The challenge is for trade unions to respond by trying to overcome the barriers to activism. The area where unions can have the most impact, and which is arguably also the most important barrier to change, is the continued lack of demand from trustees. Despite the existence of a legislative framework and political background that are supportive of greater investor activism at the moment fund managers still report little interest, or pressure, from trustees. As such debates are often pegged back to the positions of the major shareholder bodies and in specific cases of investor activism unions are almost always absent.

In essence then the role of the TUC and member unions remains unchanged from previous assessments of the potential for investor activism. It is to focus time and resources on member trustees to increase their competence and confidence, and to erode the resistance to responsible investment.

[1] Will UK pension funds become more responsible? Just Pensions report, page 13

[2] Will UK pension funds become more responsible? Just Pensions report, page 26

[3] Bill Mott, Credit Suisse Asset Management, Financial Times, 9 February 2002

[4] The role of institutional investors in the boom and bust, an essay featured in Boom and Bust: the equity market crisis - Lessons for asset managers and their clients, European Asset Management Association

[5] The role of institutional investors in the boom and bust, an essay featured in Boom and Bust: the equity market crisis - Lessons for asset managers and their clients, European Asset Management Association

[6] The City: Inside the Great Expectation Machine, Tony Golding

[7] 'Another factor which could have a significant impact on the flow of pension fund money into private equity is the gradual move from defined benefit pensions to defined contribution pensions… [DC scheme] members are unlikely to be fully aware of venture capital or how to measure its associated risks. This lack of knowledge, together with the difficulties involved in investing very small amounts of money, will not be conducive to investment in venture capital.'

Finance for Small Firms - Seventh Report , Bank of England, January 2000. Page 55.

[8] Excessive volatility or uncertain real economy? From: Boom and Bust: the equity market crisis - Lessons for asset managers and their clients, European Asset Management Association

[9] Going off the rails: Global Capital and the Crisis of Legitimacy, page 244

[10] Having Their Cake: How the City and Big Bosses are Consuming UK Business, Don Young and Pat Scott, Kogan Page 2004

[11] Remapping our investment future, Watson Wyatt report, page 21

[12] ICGN Statement on Institutional Shareholder Responsibilities, February 2004

[13] The responsibilities of institutional shareholder and agents - statement of principles, October 2002

[14] OECD principles of corporate governance (draft revised text), January 2004

[15] 'Action in relation to shareholder engagement had been limited: only 25% of schemes had reviewed this area, and only 15% had taken a formal minuted decision to act. Most of this 15% were relying on the activism policies of their investment managers, even though the majority stated clearly that these policies had not been influential in their choice of advisers', Myners principles for institutional investment decision-making: review of progress, pg 15, HM Treasury, 2004

[16] Unlocking Shareholder Value: The Keys To Success, KPMG, 1999

[17] Restoring Trust: an inquiry into the effectiveness of the UK investment system, p61, Tomorrow’s Company, 2004

[18] Simon Billenness, Trillium Asset Management, The Corporation, pages 148-149


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