The Kay Review published its final report this Monday urging asset managers and other participants in the equity investment chain to adopt a more long-term vision and put their clients' interests first.
The review particularly urged asset managers to run more focused portfolios and move away from investment vehicles which are currently relatively short-term focussed.
Professor John Kay, who leads the review, says asset managers are key players in the UK equity market and responsible for its effective running and possible long term thinking which would ensure better returns for savers, pension funds and their sponsoring companies.
He said pension funds also need to play a role in this and need to stop putting pressure on asset managers based on short-term performance. Schemes should move away from a traditional model for asset allocation and diversification, and demand a diversity of styles from their asset managers.
Kay, a professor at the London School of Economics, said that the key people in the chain currently are asset managers and that he wants to enhance their role making it easier for them to work together with investors in improving companies' corporate governance and other key issues. He suggests an investors' forum in order to facilitate collective engagement by investors in UK companies.
According to the economist, the increasing number of intermediaries (such as custodians, pension fund trustees, fiduciary managers and independent financial advisers) who stand between asset managers and the actual savers do not make for better saver outcomes and Kay says the managers should built a more direct relationship with savers.
The report also criticised the current bonus system in the City, saying that incentives of intermediaries are too focused on short-term gain, which can be damaging to companies and the returns of pension schemes in the long run. It also states that the bonuses are reducing the returns of the actual investors.
Asset managers should make full disclosure of all costs, says the review, including actual or estimated transaction costs plus performance fees charged to the fund.
Kay also recommends applying "fiduciary" standards to more people in the chain, saying that anyone who manages money or advises people on how to invest their money should have an obligation to put their clients' interests first.
The report states: "All participants in the equity investment chain should observe fiduciary standards in their relationships with their clients and customers, and application of the legal concept of fiduciary duty to investment matters should be clarified."
Industry bodies have already welcomed Kay's focus on fiduciary standards of care.
Joanne Segars, chief executive of the National Association of Pension Funds (NAPF), said:
"This report offers some useful, practical ways forward. Equity markets must work more effectively in the long-term interests of investors and savers, who need to be able to see that they are getting value for money. The NAPF is pleased to see Kay say that transaction costs and stock lending income should be set out more clearly. Boardroom pay must also become more transparent and more strongly linked to long-term performance.
"Most pension funds delegate responsibility for company engagement to an investment manager, and Kay is right that this relationship needs to be reshaped if good corporate governance is to develop further. Pension funds need to hold their managers accountable for delivering long-term returns, and quality stewardship should be a key factor when picking or reviewing investment managers. However, at present there are many competing priorities for trustees, and managers' capabilities are difficult to assess."
Christine Berry, head of policy and research at FairPensions, said: "Professor Kay has outlined a critical agenda for reform which government should embrace if it is serious about building a more responsible capitalism.
"We particularly welcome the report's emphasis on fiduciary standards of care. Applying these standards to everyone managing other people's money would help address the chronic loss of public trust in an industry which is seen as self-serving and profiteering.
"The other side of this coin, as the report recognises, is the need to rescue this vital legal concept from the prevailing obsession with short-term returns, freeing fiduciary investors to focus on sustainable wealth creation."
In the review's interim report, which was published in February of this year, Kay already highlighted the changing role of pension funds in the UK equity market. He said that while individuals and brokers used to play a key role in the market before being succeeded by insurance companies and pension funds in 1990s (holding around half of the total), today professional asset managers were the key agents. They have taken over the right to buy and sell instead of the actual investor, and have also taken over tasks attributed to being a shareholder, such as voting.
The final review reads: "We find increased fragmentation, driven by the diminishing share of large UK insurance companies and pension funds and by the globalisation of financial markets which has led to increased foreign shareholding. This fragmentation has reduced the incentives for engagement and the level of control enjoyed by each shareholder."
"Both life insurance companies and pension funds traditionally placed funds principally in fixed interest securities, both government and corporate, and secondarily in property. From the 1960s, these institutions substantially increased their equity exposure. At the same time, the coverage of occupational pension schemes among UK employees was greatly extended. By the 1990s, UK insurance companies and pension funds were the most important holders of UK equities, accounting for around half of the total."
Though this for pension schemes meant they had rather a larger influence on the market, more recently, regulation of pension and life funds, and the maturity of pension funds, meant that pension trustees had to reduce their exposure to equity markets.
The size of the funds themselves has diminished as a share of total UK financial assets and many pension funds have outsourced their investment to specialist asset managers. "In some cases these specialists are spin offs from the sponsoring insurance company or pension fund," the review reads.
"The insurer or pension fund encourages the divested business to seek external customers. The globalisation of financial markets has encouraged UK equity investors to hold more overseas equities, and a corollary is that many more UK equities are now held by foreign institutions."
First published 23.07.2012
azeevalkink@wilmington.co.uk
