 Investors are uniquely placed to engage with government to push for more responsible fiscal policy for the good of the savers they represent. After all, capital cannot sustainably grow without a functioning society. Corporates need to share the burden of funding that society.
Matthew Parris raises some very compelling arguments in his piece in last Saturday’s Times The squeezed middle must pay more tax. He is right that a civilised society makes sure its seniors are at least comfortable and pensions need to be a key focus for government. However, I’m struggling to agree with the headline. More income tax is not the solution to creating a stable, fair society in which businesses and wealth can flourish to the benefit of all. The suggestion that individuals should carry this burden is frankly bewildering given income tax already represents 60% of government revenue in the UK. Workers are increasingly self-reliant for securing their financial futures while the protections they enjoy as employees are going backwards. This breeds discontent towards companies and politicians, neither of which is good for society as a whole.
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 The rise of passive investment presents some serious challenges to asset owners, fund management firms and society as a whole. For the shift to create a more sustainable investment environment, a new balance needs to be struck between better capital allocation decisions, better passive offerings and a more equitable sharing of risk and reward. Without that, the rise of passive could do untold damage to long-term returns.
There’s good news and bad news: passive is on the rise. According to data compiled by Morningstar for the FT, passive funds grew 4.5 times faster than their active counterparts during 2016. Meanwhile, research from Moodys shows index tracking could become the dominant form of investment in the US by 2021. This may spell good news for savers whose assets have suffered as a result of high active management fees in the past, but it is potentially very bad news for both economies and societies as a whole.  Andrew McNally is Chief Executive Officer of Equitile Investments and author of Debtonator: How Debt Favours The Few and Equity Can Work For Us All.
Andrew, in your book Debtonator: How Debt Favours the Few and Equity Can Work For All of Us, you discuss how the widespread over-reliance on debt – brought about by corporate tax regimes that favour debt, central bank action that keeps credit costs low and an ingrained, but misguided orthodoxy among bankers and business owners alike that debt is better than equity – is damaging both business and society because it focusses wealth in the hands of the few. This contributes to extreme inequality of both wealth and asset ownership, and undermines corporate sustainability. In explaining this debt-addiction, your book points to unrealistic assumptions within the economic theories that underpin financial models still dominant today. Yet, over the last few years, we have increasingly read in the press and heard from those in the financial industry that the economy is functioning differently from how it used to. To what extent do you think economic models have moved on to reflect this new economic normality? Economics as a discipline is in a state of turmoil and on the cusp of the sort of revolution historically seen in other sciences. However, economics is still taught the same way it was 30 years ago. Equilibrium as an idea has become cast in stone and is based on the idea that humans are rational calculating machines. Nothing could be further from the truth though. Despite that, central banks’ models and those used in the banking and asset management sectors to measure risk, are still sticking doggedly to this idea of equilibrium. Scrapping the idea of rationality would, therefore, upend most of the models used in finance today. Long-term companies provide superior financial returns, better fundamentals and a more positive impact on the economy and society. Fund managers, in turn, need to take a longer view, exploit the outperformance offered by long-term firms for the benefit of their clients, and encourage more corporates to think long-term.  A few days ago I was chatting to a fund manager at one of the biggest UK fund houses. There was gin involved so I can’t recount the whole conversation word for word, but he did say something that stands out. We were talking about the need for long-term investors to consider the wider implications of their allocation decisions and think long-term – or at least this was what I was banging on about – when he said: “I see a 20 year investment horizon as a collection of 4-5 year investment horizons. There is what we ‘should’ do, and then there is being pragmatic.”
This got me to thinking: Does pragmatism force investors to take a short-term view? Not according to the McKinsey Global Institute. Their report Measuring the Economic Impact of Short-Termism, issued a day after my conversation with this fund manager, summarised the findings of their research thus: “Our new Corporate Horizon Index provides systematic evidence that a long-term approach can lead to superior performance for revenue and earnings, investment, market capitalization, and job creation.” The report rolls from one finding in support of long-termism to another: long-term firms exhibit stronger fundamentals, growing their revenue cumulatively 47% more on average than other companies and in a less volatile manner, allowing them to weather the financial crisis better; they continue to invest in difficult times, spending significantly more on R&D, which helps them maintain consistent and sustainable sources of growth - key goals of long-term planning (see charts below).   Faith Ward is Chief Responsible Investment and Risk Officer at the £3 billion Environment Agency Pension Fund (EAPF).
Faith, the EAPF has been an actively responsible investor for over 10 years. To what extent do you think considering ESG factors is central to fiduciary duty? It is absolutely central. Those with fiduciary duty need to look at all the ESG-related risks and how materially they could impact an investment. That means really looking at the risks and opportunities, not just the traditional metrics. Do you think the definition of fiduciary duty needs further clarification when it comes to ESG? The Law Commission review in the UK made it clear ESG risks have the potential to be significant, but reinforcement through other mechanisms would help. The existing regulatory framework, for example, needs to reinforce that message. This reinforcement needs to happen globally. Do we need more regulation regarding ESG? A lot of the framework is already there. The critical point, though, is how those rules are interpreted, implemented and reinforced. Making them matter and interpreting them in a more positive manner is an important next step.  Snap's IPO plans demonstrate why the ISG's Framework for US Stewardship and Governance is so desperately needed.
As if to demonstrate why a stewardship and governance code is so badly needed in the US, Snapchat’s IPO plan, designed to raise $3bn for the company, will only offer shares with no voting power (today’s FT). The Council of Institutional Investors has 'strongly urged' Snap to reconsider, while Calpers criticised Snap's ‘banana republic-style' approach. Their concerns are well founded.  The Investor Stewardship Group’s Framework for US Stewardship and Governance comes as very welcome news among the melee of negativity flowing out of the US over the last week.
The collective clout held by the group of 16 US and international institutional investors representing a combined total of just over $17 trillion is very considerable and sends a very strong message to corporate America about how investors expect them to behave. I’ve heard a lot of fund managers and investors complain in recent weeks about the lack of ESG frameworks in the US, which has made it harder to hold companies to account and get them to engage. In no small part, this has been to blame for the significantly higher levels of executive pay Amercian CEOs still enjoy relative to their global peers. Data from MSCI shows that for companies included in the MSCI World index, US CEOs' average total compensation far exceeds that of their international rivals.  Traditional capitalism failed so many for so long because it failed to capture the unintended consequences of how it functioned. We need a more informed version of capitalism, under which investors recognise the wider risks they create in societal and environmental terms and take responsibility for managing those risks.
Last week, while engaging in a little commentary on LinkedIn, I suggested that populism was a growing concern across Europe because ‘our capitalist system has failed so many for so long’. Another member subsequently posed the question: Why has capitalism failed? Europeans/Westerners still enjoy the best standards of living in the world. While I would agree with the latter part of this response, I feel it warrants further exploration. |
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