Every lesson helps
Here are 12 things arising from the Tesco accounting debacle that pension funds could deploy which would help prevent, or at least mitigate, similar implosions. This needs to be a two-way process. My questions are forward-looking and include some that investors can ask of asset managers. Since space is limited, readers are welcome to contact me for more.
• First, motivate yourself to act: calculate and make known – as widely as you dare – what your fund has lost in this case, in both your active and passive portfolios.
The following three points involve investment decision making:
• If using active fund managers, bite the bullet and give unconstrained mandates and also ask the fund managers which companies they have serious concerns about. That is important information for you.
• Where there are substantive concerns about a company that is a significant part of the index ask your managers (including passive managers) to commission analysis that cannot be easily gamed (eg, emotional context of general communication or customer, staff, supplier views) to shed light on what is really happening.
• Ask your fund managers to show they incentivise challenging (‘enhanced’) sell-side and independent research and when that research is brave enough to challenge major companies, ask them how they act on it.
The remaining points involve stewardship and voting. Investors should either vote directly or ask managers to vote in accordance with the following:
• Ask companies to move away from quarterly guidance and instead report on return on capital and forward-looking drivers of business success.
• Ask that important board roles have a meaningful job description and that headhunters see candidates outside the normal gene pool. Check that the board evaluation process is working to good standards (does the evaluation have access to a board meeting, see individuals other than the board members, does the evaluator report on whether the report changed significantly after comments from the chairman, is the evaluator responsible for a plan of action? Similar factors apply to board evaluators.
• Vote against chairmen and directors who are clearly not suited (eg, former executives who used to report to the CEO or board members who have sat on boards that did not perform, regardless of whether the vote will be successful or not.
• Vote against remuneration packages that incentivise growth over profitability, short-term targets over long-term health, and secure the specialist research help you need to be able to make good judgments.
• Ask companies to ensure they have independent and credible whistle-blowing and ombudsman functions in place.
• Ask companies to separate the audit and risk functions as the vast majority of FTSE 100 financial services businesses now do, or at least ensure the joint committee is chaired by a non-executive director who has good non-financial risk experience.
• Vote against an auditor who has been in role for more than 10 years when there are already concerns about accounting behaviour and or where there is non-audit fees, regardless of whether the vote will be successful or not.
• Once it is clear the board is not changing in response to constructive engagement, then alert members of fund to this reality (compare the adult-to-adult relationship that doctors now have with patients when there is a serious health risk that has to be lived with).
Similarly, once it is clear a manager is not willing or able to do stewardship activity, then find a better one. Such authenticity could usefully trigger wider consumer or citizen action on things that one fund or even a group of funds are unable to address.
Raj Thamotheram is CEO of Preventable Surprises and a visiting fellow at the Smith School, Oxford University, and Aidan Ward is an organisational systems consultant