An engaging incentive

As the Treasury Select Committee  (TSC)  hearings rumble on, professional investors have been under close scrutiny.  Had Alistair Darling had the foresight to tax the word ‘responsibility’, he could probably have recouped a large slice of the unprecedented sums the public purse is currently spending. Investor responsibility  raises two very simple and potentially conflicting questions. Should I disinvest or should I engage with the company?

The TSC heard that from 2005, investors voted with their trading buttons and with only then with their voting buttons; in Manifest’s evidence submission last week we demonstrated that the facts do not support the assertion. The sell-off deserves closer scrutiny,  especially given the growth in engagement as a part of an investment strategy.

Eurosif’s 2008 SRI study shows how mainstream SRI has now become (rocketing by 104% in two years) and how the UK is conspicuous in its leadership of engagement as an ownership strategy. In 2006, the UN set up a ‘clearing house’ for collaborative engagement between investors. So why does engagement  for non SRI appear to have  failed?  Robert Peston’s intriguing 2008 book entitled “Who runs Britain?” takes an interesting perspective.

Passive investors are invested ‘by default’,  passively opting in to ownership rather than  as measure of confidence in the board – not an ideal base from which to really make a difference.  Underweight positions (the nearest they can get to disinvestment) create a perverse disincentive to engage for change as they would lose out proportionately.

All other things being equal, the ‘momentum’ of a long-term strategy means that investors are less likely to effect urgent change when it’s needed than short-term ‘activist’ investors. As the press have highlighted at length, a cosy familiarity with the board cane result in a reluctance to rock the boat.  A short, sudden momentum can often make for quick results (good or bad). The Children’s Fund and ABN Amro is a good case in point.

Understanding why governance engagement seemed to fail is not as simple as pointing the finger at shareholders allegedly asleep at the wheel. Just as we’ve learned that bank directors’ incentive structures encouraged ever-riskier business models in recent years, owners should ensure that the fees investors are paid for managing their money encompass a wider, more inclusive stewardship brief.

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