All sorts of corporate governance guidelines are being discussed these days, including a global set being formulated by the OECD. In the midst of all this activity, it is well to remember that those with the money are most likely to shape the future of corporate governance. If this is so, what provisions do institutional investors care most about?
At a recent Conference Board Governance Center meeting, leading institutions and investor advisory groups (such as Institutional Shareholder Services) came together to discuss their corporate governance guidelines. While there are some clear differences between the various guidelines, there is also a surprisingly consistent theme throughout. Virtually all of the institutions and advisory groups came loaded with the explicit recognition that investments should be undertaken for long-term return, not for short-term trading gain.
During the last decade, no issue has polarized corporations and institutional investors quite as much as ‘short-termism’. This is the oft-accepted notion that institutional investors were at heart only speculators or traders and would, at the drop of a hat, sell out company management for a raider’s premium. Institutional investor guidelines stipulating the desirability of long-term investment offers a challenge to this conventional wisdom.
True, many US fiduciaries did sell out to raiders during the 1980s takeover wars. In order to justify this they cited regulations pursuant to the Employee Retirement Income Security Act (Erisa) which, they argued, compelled them to sell or risk being surcharged if they passed up a takeover premium and found the stock price lower. But pension funds were still getting a bad short-term rap long after joint regulations issued by the US Departments of Labor and Treasury in 1989 clarified that pension fund fiduciaries could justify rejecting a premium if they believed management would produce higher long-term value for shareholders.
Moreover, in recent years, cases where investors stayed with management (for instance Chrysler fending off the bid by Kirk Kerkorian and Tracinda) show that institutions are not lemmings rushing to fall off a cliff. Yet, you will still hear CEOs lament the lack of loyalty among their institutional investors.
Don’t walk
TIAA-Cref’s approach is consistent with that taken by many of the other large institutional investors. TIAA-Cref is the largest private pension system in the world with approximately $225 bn under management. Peter Clapman, senior vice president and chief counsel, notes that TIAA-Cref’s history of corporate governance involvement goes back to the early 1970s, when the fund rejected the so-called Wall Street Walk. This was the rule then followed by most investors to sell stock when unhappy with management.
TIAA-Cref managers believe that the most responsible, and in the long run by far the most successful, investment approach is to present shareholder concerns directly to company management to encourage them to make the necessary changes. Moreover, the fund’s policy statement says: ‘The primary responsibility of the board of directors is to foster the long-term success of the corporation consistent with its fiduciary responsibility to the shareholders.’
Practice what you preach
But do public pension funds actually invest for the long term? The Conference Board’s data examines pension fund investment profiles, turnover and trading patterns. US institutional investors had an average annual turnover of 42.5 percent in 1997 according to 13f quarterly filings with the US Securities and Exchange Commission (this information is derived by analyzing the Georgeson & Co database). These filings are made by institutions that have investment control of $100 mn or more in assets and have the ‘hands-on’ responsibility to invest this money.
By this definition, when a pension fund actively manages money internally, turnover data pertain to that pension fund. But, when a fund delegates money to a bank, it is the bank that files the 13f and the data track the bank’s equity turnover.
The figures in the tables below show the 1997 turnover rates for actively managed portfolios of four major types of institutional investors: public pension funds, corporate pension funds, banks and money managers. Money managers have the highest average turnover, at 53 percent, while public pensions managing their own funds have the lowest average turnover, at 19.3 percent. After public pension funds, the institutions with the next lowest level of turnover are the banks, with 29.9 percent average turnover, followed by corporate pension funds, with 36.3 percent.
Even more revealing than aggregate turnover numbers, however, are turnover data for the sub-components of institutional investor portfolios. Institutions invest according to a variety of strategies, such as aggressive growth, classic value (pursuing Graham Dodd-style of investing in low PE ratio or low ratio of market value to appraised intrinsic value), and indexed.
Turnover is highest for the aggressive growth strategy – especially for money managers, which recorded a 95.1 percent turnover in 1997. Indexed funds are at the low end of the turnover range, where, for example, public pensions managing their own indexed funds have only a 16.4 percent turnover. Since neither public nor corporate pension funds invest greatly in aggressive growth stocks, their overall turnover is quite low compared to banks and money managers.
Delegation time
These data show that when these funds manage their own investments, they appear to practice what they preach. But a major issue remains: to what extent are institutions managing the money on behalf of corporate and public pension funds expected to adhere to these same long-term investment principles?
In the US, state and local public pension funds send out 60 percent of their assets to be managed externally, while corporate funds delegate about 45 percent. Olena Berg, former assistant secretary at the US Department of Labor, told a Conference Board audience that corporate pension funds would be deemed to be fulfilling their Erisa responsibilities if they decided to monitor the turnover of the portfolio assets they delegate to fund managers. This is because pursuing a strategy of low turnover and investing for the long-term can be as appropriate an investment strategy as, for example, diversification.
If pension funds really practiced what they preach, they would not only subject the money they invest to these low turnover, long-term investing guidelines; they would monitor all their equities in the same fashion – even those delegated to others to invest.
Dr Carolyn Kay Brancato is director of The Conference Board’s Global Corporate Governance Research Center
