INVESTOR GOVERNANCE REVISITED:

The risk and reward of democracy in institutional investment decision-making

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12th Development Dialogue

‘Rethinking Democracy’ Colin Habberton

ISS, The Hague,17 October 2014

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Introduction •  The rich are getting richer and the poor are

getting poorer quicker than ever before (Piketty, 2014) due to the return on capital.

•  Financial markets host the trade of capital instruments within and across nations.

•  Institutional investors dominate the investment activity within financial markets (Blume & Keim 2012; OECD, 2014; ASISA, 2013).

•  The paper investigates whether institutional investors consider the interests and opinions of individual capital contributors.

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Democracy

“If liberty and equality, as is thought by some, are chiefly to be found in democracy, they will be best attained when all persons alike share in

the government to the utmost.” Aristotle

Historical Evidence

(Source: Piketty, 2014 Adapted)

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Return on Capital v Growth Rate

R > G (Piketty, 2014)

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Research Questions •  Is good governance applied and practiced in the

by institutional investors in taking responsibility for investment decisions on behalf of stakeholder communities?

•  Should individual contributors participate in decision-making processes, holding institutional investors as their agents accountable?

•  Should institutional investors be more proactive in providing access to information, education and opportunity to participate in decision-making?

•  What are the risks and rewards?

Research methodology

•  The analysis of the existing regulatory and normative frameworks forms the theoretical foundation of the paper.

•  Secondary literature research refined the conceptual framework to inform the selection of population, sample frame for interviews.

•  The consequent understanding of the theory, industry and experts was integrated into the design and execution of semi-structured interviews with industry experts.

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Research sample

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The Rise of Responsibile Investing

•  Role and rise of institutional investors • Dominance of total assets under management

•  ‘Responsible’ Investing •  ESG Orientation •  Awareness of issues of sustainability in profit •  UN Principles for Responsible Investing (PRI)

•  Importance of normative frameworks •  UN Global Compact, UNEP-FI •  Cadbury Report, King 1,II, III •  PRI & CRISA 9

Institutional Investor dominance

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•  Over 67% of market capitalisation in the USA •  Own 73% of the US’s 1000 largest companies •  33 OECD countries average is 40% ownership

(Source: OECD, 2014)

Principles for Responsible Investing

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(Source: UNPRI, 2014)

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•  Increasing support for normative frameworks •  UN Principles for Responsible Investment (PRI) •  CDP & Integrated Reporting <IR> Initiatives

Growth of Responsible Investing?

(Source: UNPRI, 2014)

US$45tn AuM 1200+ Signatories

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“All retirement funds, long term insurers, collective investment scheme (CIS) management companies are treated as

institutional investors…” (SARB, 2013)

•  Asset Owners •  Public Sector: GEPF, Transnet, Eskom, parastatals •  Private Sector: Over 5000 funds FSB registered

•  Asset Managers •  Public Sector: Public Investment Corporation •  Over 200 Retirement Funds & CIS companies •  Over 100 Insurers

Institutional Investors in South Africa

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•  Comparative Analysis: SAFI Relational Matrix •  ASISA Membership Base •  UNPRI/CDP/<IR> Signatories •  SARB & FSB Registration

•  Interim Findings: •  Of the 45 SA UNPRI Signatories •  5 out of 5800+ Asset Owners, 1 Private Sector •  33 out of over 200 Asset Managers •  Role of Asset Consultants in the process

Institutional Investors in South Africa

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•  SA one of the leading countries on the African continent in terms of governance (Mo Ibrahim Foundation, 2013)

•  King Reports & Institute of Directors SA •  Influencing business and legal practice

•  King III – Sustainability & Stakeholders •  “…characterised by the ethical values of

responsibility, accountability, fairness and transparency…based on the moral duties that find expression in the concept of Ubuntu.”

Governance in South Africa

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Pension Funds: A Systemic Model

(Source: Clarke, 2000)

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•  Role of Professional Investor •  Fiduciary responsibilities as an agent

•  Accountability of pension fund trustees •  Skill vs. experience vs. representivity

•  Appointed by wide range of Stakeholders •  Transparency of decision-making process

•  Investor participation & inclusion •  Need for transparency & engagement

•  Investor education & responsibility •  Creating & understanding mandates

Investor Governance

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•  Institutional PRI/CRISA participation •  Perception of institutional ‘window-dressing’ •  Unanimous acceptance of importance of ESG

•  Investment decision-making •  Delegation of decision-making to skilled specialists •  Influence of unregulated asset consultants •  Fee structures heavily geared towards benchmarks

•  Responsibility •  Different perspectives on definition of responsibility •  Maximisation of return overriding intent •  Evidence of ‘change agents’ and awareness

Findings: Institutional Investor Interviews

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•  Risks •  Resistance to concept by the ‘professionals’ •  Requires additional resources and time •  Potential disregard for analysis and depth •  Inefficient, chaotic driven by sentiment •  Lack of investor literacy and prudence

•  Rewards •  Increase institutional investor accountability

to ownership responsibilities •  Highlight the importance of ESG decision-making •  Increased demand may enhance choice

Individual Investor Participation

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•  Investment industry characterised by profit driven strategic and systemic constraints.

•  Improved access to information, transparency in investment processes needed.

•  Role of asset consultants and their influence over decision-making is significant.

•  Investment mandates and fee structures are drivers of investment behaviour.

•  Institutional investors should assume responsibility and accountability for their decisions as agents of stakeholders.

Conclusions & Further research…

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“With great power comes great responsibility.”

(Voltaire)

Final Word & Questions

INVESTOR GOVERNANCE REVISITED

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Colin Habberton

colin.habberton@relativ.co.za @relatomics