How shares work (for us and our pensions)

Shares haven’t worked well for us over the past twelve years. World stock markets, especially the mature markets in Britain , Japan and the US, are worth less today than they were at the turn of the millenium.

While some company’s shares have paid dividends that have offset these losses, the expected overall returns have been less than expected. This is one of the reasons defined benefit pension schemes have deficits.

Nobody expects stock markets to regularly provide the double digit percentage returns that became the nom in the eighties and nineties. Pension schemes and ordinary consumers are now more realistic in what we can expect and if we can have a return that simply beats inflation by 2 or 3%, we are generally happy.

In these straightened times, the impact of losing half a percent in returns from a fund manager’s charge or a cut in dividend payments means much more than it might have done when our return expectations were over 10% per year.

Which is why the spotlight has turned onto the managers of the share portfolios into which we invest. These managers are generally managing shares on our behalf and are the direct owners of the equity in the company in which they invest. They have the voting rights and have responsibility to make sure that the management of the companies they invest in are doing a proper job.

If for instance , Barclays choose to pay their CEO Bob Diamond a few million quid for his year’s work, the shareholders have the right to ask whether the amount is proportionate to the value he has brought to Barclays’ shareholders. As it happens, last week saw two examples (Barclays being one and Citibank the other) where the managers of share portfolios stood up and said “no”, we are not letting you take that decision, go away and come back with a better plan.

This process, known in the City as Governance or “Stewardship” is notoriously difficult. The main problem is that shareholders are numerous and are not organised to act together. This problem has partly been addressed by groups of similar managers – insurers through the Association of British Insurers, pension funds through the National Association of Pension Funds, clubbing up- maybe ganging up is a better expression, to vote together. In the case of Barclays, it was the insurer Standard Life who got things going and the ABI who applied the pressure. However, the fires had been lit by shareholder activist groups like PIRC and Hermes without whom I doubt Standard Life and the ABI would have bothered.

Ultimately it comes down to a few people- like Alan MacDougall at PIRC and Alastair Ross- Goobey at Hermes to get things going. Though it’s taken them decades to get this far, without them going on and on about the need to exert pressure on management, we would not be in the position we are today.

But we are only a tiny way down the road and the vast majority of corporate decisions not just on executive pay, dividend strategy but also the company’s attitude to social responsibility are nodded through without scrutiny.

In order to improve the level of scrutiny we need two things. Firstly a consensus that this scrutiny is worth it. I can’t prove that it is in a blog like this but there is a gathering body of evidence that suggests that good governance leads to better returns to shareholders.

Secondly, assuming we believe that shareholders get more value (after the cost of scrutiny) from this governance, then we need to make sure it is being carried out.

One of the biggest obstacles to this second task is the complexity of fund ownership. You might think you are investing in your personal pension with Zurich, but your funds may be managed by Black Rock or Legal and General or a combination of these two and a cocktail of other managers. Infact you are investing in a Zurich insurance policy and it’s Zurich who own the units in the funds in which you are invested.

So its up to Zurich (not you) to make sure that the managers they employ are putting the right pressure on the managers of the companies in which you are invested.

 I told you it was complicated.

To make the shares work for us we need to be sure that Zurich are exerting pressure on their fund managers who in turn are exerting pressure on the managers of the companies in which your money is invested.

While some fund managers are doing a good job, others aren’t.  This is why Fair Pensions, an organisation set up to make sure that all people investing in pension funds get fair treatment, has researched and reported on this  issue.

The report‘s findings include;

– Only one of the insurance companies surveyed is a signatory of the UK Stewardship Code.
– Monitoring of voting and engagement is, for the most part, restricted to internal asset managers. Only one insurance company who answered the survey requests reports from external asset managers on their voting records.
– None of the companies who completed the survey requests reports from external managers on their engagement activity with companies.
– Only Standard Life PLC makes any information on voting and engagement publicly available on its retail website.

The report also found that only one of the ten companies surveyed has a publicly disclosed responsible investment strategy separate from the policy of its asset management arm.

The report comes in light of pension savers still feeling the effects of the financial crisis(3) on their savings and a wide acceptance that the stewardship activities of pension schemes are a key factor in reducing risk and adding value for savers.

The report calls on employers – many of whom are in the process of selecting a pension scheme for the start of auto-enrolment – to ask searching questions of pension providers about their oversight of asset managers.

Louise Rouse, author of the report, noted that insurance companies are leaving pension savers less protected than their trust-based counterparts:

“The unwillingness of insurance companies to regularly monitor external fund managers leaves contract-based pension holders ill-served and poorly protected compared to fund members in the best governed trust-based schemes”

Ms Rouse, went on to say:

“Ultimately it is savers who suffer when a pension provider fails to monitor their asset managers. As millions of people enter the pensions market for the first time, they will want to know that their pension provider, whether trust-based or contract-based, is protecting their best interests.’

The business of getting engagement is slow and requires patience. It’s encouraging that the momentum built up by the people I mention in this article (and many I don’t) is finally bearing positive results.

Articles like this may not accelerate the process of change, but if they raise awareness a little, they have moved the argument on.

For shares to work for us again, we need to manage what Andrew Kirton of Mercer refers to as the “upstream issues” of governance (or Stewardship as Fair Pensions calls it). We also need to manage the “downstream issues” of the costs levied by the Fund Managers and the insurers who offer us the fund platforms and the contract based pensions most of us now use.

We cannot do this directly , we need organisations like Fair Pensions to help us. They deserve our support and recognition. The unsung need to be sung!

If we don’t ask the questions they are asking, then we will not get the value from our shares that we should and in the end, we won’t get the pensions we expect.

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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12 Responses to How shares work (for us and our pensions)

  1. martin says:

    Well said Henry. I expect the replacement of defined benefit with defined contribution schemes (and more SIPP) will make many people a lot more aware of the returns being achieved by fund managers and I hope put pressure on the high rate of fees they charge: It is disgraceful that managers charge at least 1.5% to more or less just track an index and then do nothing to promote good corporate governance.
    Greater transparency is a start and activism will follow. Institutional fund managers also need to develop a greater awareness of their responsibilities as long term representatives of the shareholders.

    • Derek Scott says:

      Transparency and so-called activism are chimerical.

      What you really need is co-investment and alignment of interest. The kind of alignment that closes funds from time to time in order to manage scale in a market context, the kind of alignment that avoids overvalued equities and has the buy, hold or sell and re-investment discipline needed to cover for occasional bad buys and generally to compound returns. The kind of alignment that engages with management and competitors and customers, that challenges management’s dividend policy, expensive share buybacks and misaligned executive remuneration packages.

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