SUMMIT WHITE PAPER RESPONSIBILITY, CONTROL
AND THE INSTITUTIONAL INVESTOR
When the world’s largest car manufacturer falls on hard times, analysts, commentators and public alike tend to sit up and take notice. Long regarded as the epitome of Japanese innovation and industrial strength, the Toyota Motor Corporation has been forced into a humiliating recall of 8.5 million vehicles, and seen its share price fall by 20 points in less than a month. Unsurprisingly, the calls for culpability and action have been both swift and vociferous. Like Toyota, our industry has suffered repeated shocks of late, and many institutional funds have yet to recover from the unprecedented financial impairments of 2008 and 2009. With global pension funds alone collectively holding many trillion pounds in assets, this puts even the travails of Japan’s industrial champion in perspective. But to whom can ordinary investors turn for answers and accountability? And are those bearing this responsibility sufficiently equipped to live up to it? The buck stops at the top The faulty brakes and sticky accelerator peddles that triggered the recalls can be fixed. The financial damage to Toyota’s balance sheet and competitiveness may, too, be relatively short lived. The real damage, however, has yet to be fully accounted for; the effect on consumer confidence will impact future sales by a far greater factor than short‐term drops in stock value or vehicle recalls. But who should shoulder the responsibility for Toyota’s woes? Was the sourcing department that procured the parts at fault? Were the factory employees who fitted
the defective components culpable, or should we ask questions of the R&D department? The truth undoubtedly lies in a combination of the above and many more. Yet it was the company President, Mr Akio Toyoda, who – in a stark contrast to the handling of the banking crisis – stood in front of the world’s press on 13 February and, after a deep apologetic bow, announced that he was fully accountable. He did this because he was supposed to be in control of his company.
An example to institutional investors? No matter which band wagon the press and politicians choose to jump on, the simple fact remains that trustees are the Mr Toyoda of the institutional investor community. They have been entrusted with responsibility for their members’ interests, and have the ultimate authority to make investment decisions. It is imperative, therefore, that they have the control mechanisms in place to know if their investment consultants (R&D departments), fund managers (factories), and custodian (sourcing department) are inadvertently contriving to lose hundreds of thousands, or in some cases millions, a day.
Global events have again emphasised the importance of control, and the consequences when it is not exercised. In learning the lessons of this recession, institutional investors are re‐ appraising the extent of the control they have over their investments, and how this can be improved in the future. Why is control so important? Responsibility Trustees have either been elected or appointed to represent their members. They have been entrusted with control over other people’s life savings and future wellbeing, and are accountable for every single action that affects those investments. Such responsibility demands full transparency of investment activity, and sufficient due diligence checks to keep a finger on the pulse. Return For any investor, maximising return is the number one objective. An investor in control receives accurate information in a timely fashion, and is able to react to, or even pre‐empt, market movements and other events. They should have access to a wide range of indicators that can be called upon before making decisions. Such information should go much deeper than traditional monthly or quarterly performance measurement – encompassing factors such as risk, attribution and cost control on both the micro and macro level. Regulation Like it or not, more stringent regulation is both inevitable and imminent. For a prelude of what is coming down the pipeline for institutional investors, look no further than President Obama’s
comments of 21 January regarding the breaking up of the big banks. Summit’s prediction is that forthcoming regulation for institutional investors will be two‐ fold. The first element will focus on the basis for decision making. Much as outlined in the Markets in Financial Instruments Directive (MiFID) – regulations implemented in 2007 governing the investment
services community in Europe – institutional investors will be required to justify why they made key decisions by documenting all the factors taken into consideration at the time. This means that institutional investors will require access to a full history of the asset and risk modelling, costing and performance scenarios considered for the chosen portfolio, as well as all the alternative solutions. The second element will focus on clearly demonstrating the extent of the control institutional investors exercise over their investments. The new regime is also likely to demand much improved processes for monitoring risks and compliance. And again, these will need to be transparent to regulators, and therefore investors are simply going to have to change their internal procedures and systems in order to comply. It does not require a leap of faith to imagine a scenario in which a trustee board is hauled in front of a tribunal and, together with their appointed pensions manager and investment committee, is required to justify their choices and decision‐making
processes. Over the last four years we have seen a large increase in the number of investors taking legal action against companies when significant slumps in share prices could have been avoided. We have to assume that it will not be long before members of pension schemes will demand similar compensation for damages when trustees are proven negligent or incompetent.
over the investments undertaken has if anything diminished. If pension schemes and charities around the world are to avoid repeating the mistakes of the last decades, then pro‐activity is needed at their end of the investment spectrum. We must shift the control of investments to where the responsibility for the consequences resides. This clearly requires urgent action at the investor level. Change is never easy, but the alternative doesn’t bear thinking about. Our industry simply cannot afford another setback on the scale of the last recession. Should there be more reports of 30 percent falls in value within the next 5‐8 years, then we predict that member confidence will be lost for good. And more than DB schemes would suffer – our industry would be irrevocably changed for the worse.
Control in the future As with the Toyota Motor Company, the institutional investment community is now under great scrutiny, and its next steps the source of both interest and debate. Mr Toyoda has responded by personally leading a task force to review where mistakes were made, and how to avoid a repeat of the current damaging scenario. His acceptance of personal responsibility, and commitment to resolving his firm’s problems, included a promise to the US congress that he would fly to Washington to represent the company. With that kind of accountability emanating from the top, we wouldn’t bet against Toyota digging themselves out of this hole in time; albeit not in the short‐term. Our industry has to accept at some level that the wheel is broken. For quite some time there have been insufficient control mechanisms available to investors. So, while they have retained total responsibility for ever more complicated investment strategies and an increasing roster of external managers, their control
ANDREW CAIRD is Managing
Director of Summit Global Investor Services
For more information about investors in control, visit www.summit‐gis.com.