The ascent of fund management
The fund management industry is exercising increasing power in financial markets, and there are implications for companies and for IROs, argues Richard Davies.
One of the more interesting aspects of the debate around governance is the question of who governs the owners. We have heard much of the advance of the governance agenda since the 1980s in terms of the increasing influence of fund managers and asset owners over the behaviour, and sometimes fate, of public companies and their directors.
The Governance and Stewardship Codes are now well advanced in age, and most companies have woken up to the fact that institutional investor scrutiny of their business is deep and profound, especially when it comes to voting at shareholder meetings. I have long argued in this column and elsewhere that the IRO who ignores the governance analysts, and the proxy advisory agencies that often guide them, does so at their peril.
The pressure on equity issuers to behave themselves does and will not let up. We have moved from the critique of corporate behaviour by governance analysts, leading to direct engagement or the withholding of voting support, to the filtering by these analysts of investee companies for investment by portfolio managers, to the most recent scenario where some of these analysts have the power to instruct portfolio managers to sell stocks, whatever the impact on fund performance.
The rise of governance investor power over companies has taken place at the same time as the proportion of shares held in Western European equity issuers by passive, index and quant investors has risen to almost half of the total institutional money. Given the additional transparency on pricing that the regulators wish to bring to bear on traditional long-only fund managers, who arguably have acted hitherto in a somewhat obfuscatory manner with regard to their real performance, and the growing realisation that most investment managers do not significantly beat the index, particularly over a longer time period, the rise of passive funds in particular looks set to continue.
While active asset management may be on the wane, the role of fund management in general is on the up. The buy side has been growing due to the historically low interest rate environment – money has been pouring into the passive funds, particularly into the exchange-traded funds market.
As the increasingly beleaguered sell side wrestles with the current and future impact of MiFID II on earnings brought about by the reduction in income relating to trading, corporate access and research, the asset managers are becoming kings of the market. As bonuses for investment bankers have shrunk, the take-home for asset managers has risen in line with their assets under management.
Data from Emolument, a UK salary benchmarking business, quoted recently in Financial News, confirmed that London investment bankers’ pay has fallen by 2% over the last four years, while total pay for asset managers has risen by 28%. The trend is towards parity of pay across the two industries, which has until now not been the case, although average salaries are still tilted towards the bankers.
This is part of a wider shift towards investors taking a stronger role in corporate life with higher levels of engagement. Far more traditional fund managers lay claim to the title of activist these days, for example.
Investors are also increasingly involved in political life, especially in the US, where fund managers, particularly the governance-oriented funds, have been using ‘private ordering’ interventions to fight against the attempt by Trump, via the recently installed Financial Choice Act, to reshape markets to the benefit of the corporation against the investor.
Private ordering is basically the process of shareholders and companies agreeing between themselves how a company should govern itself, outside the remit of government and the regulator. Even if the Financial Choice Act has rolled back statutory investor powers, fund managers can continue to hold sway over company behaviour through these private arrangement mechanisms. The US still lags Europe in terms of investor influence over board composition, but ‘private ordering’ to allow ‘proxy access’, the right to vote directors on or off boards, is a growing trend right now. Fund managers are not going to give up their hard-won victories so easily.
In the pan-European market, the buy side has and will take up an increasing amount of time for IR teams, relative to the sell side. As MiFID II kicks in, the number of analysts overall will fall as the number of stockbrokers decreases and those brokers remaining give up their ‘waterfront’ all-sector research coverage. More fund management firms will have their own corporate access teams and run their own research, so direct approaches from asset managers to companies will increase further.
While it is important not to overstate the flow of research analysts and investment bankers to the buy side, one could argue that we will see many more boutique investment companies being set up, which use the skills of the sell side in an asset management framework.
Wherever the river of regulation takes us in terms of the restructuring of the relationship between the buy and sell sides in practical terms (and nobody seems to have a clear answer on that yet), one can guarantee that the capital markets will never be the same again. Fund management is a culture in ascendance, at least until the next crash.
Richard Davies is founder and managing director of RD:IR
Published 20 July, 2017