Assessing responsible managers
How can pension funds assess the responsible investor credentials of their managers? A member's association with his or her pension scheme may commence when his employment begins, extend through their working life, extend through retirement while a retirement pension is paid and extend beyond death through the pension payable to a surviving spouse. In all, the association may approach a century in duration.
Such a timescale gives abundant opportunity for the enterprises of which the scheme is part owner, to play their part for good or ill in the member's life, both financially and through their impact on the environment in which the member must live.
Over a decade - less than a tenth of that timescale - we should also expect the effects of good governance and corporate responsibility to be borne out in the results of investee companies.
The USS view is that the evidence shows that paying attention to good governance and corporate responsibility at worst, does not hinder the performance of funds and in the long-term is likely to be of significant benefit.
The interest of members and other pension scheme stakeholders in promoting good governance and corporate responsibility is clear enough. Schemes' ownership of substantial portions of stock markets imply both the responsibility and the potential to influence.
These considerations have led USS and other schemes to incorporate into their Statement of Investment Principles a requirement for responsible investment.
For the investment managers therefore, this involves:
q Taking into account considerations of good governance and corporate responsibility in the analysis of potential and current investments;
q Engaging with investee companies to bring about good practice in these areas.
For the trustees, this involves:
q Assessing the manager's capability in this area as a part of manager selection;
q Monitoring the manager's ongoing performance in this area in the same way as is done for the other aspects of investment performance.
It is important to note that for USS, responsible investment has nothing to do with ethical screening. It is concerned with the good governance and responsibility employed in producing goods and services, not in any moral value which might attach to the products themselves. The university sector is not the homogenous moral community which would be required if screening were to be imposed.
To assess to what extent a manager is a responsible investor, and also to help pension funds manage the risk of not being compliant with the ISC principles, USS has devised a checklist. We do not expect to be able to give a simple yes/no answer, but rather through responses to questions which are graded, place managers on a spectrum so that we can say, for example that so far as building corporate governance into the investment process is concerned, manager A is amongst the leaders in this area. Specifically, the manager is well resourced to carry out this activity, is willing to pursue these issues with companies etc.
The questions were devised based on our observations of good practice in each of our investment managers as well as from discussions with other managers who although not USS managers, are leaders in this field. We expect the refinement of the concept of responsible investor to continue the some time yet.
The basic tenets are:
q The leadership of top management is needed to build the new development into the manager's organisation;
q Information needs to be available and to be built into the normal processes (such as stock selection) if these considerations are to count as part of the investment process;
q Specialist staff are needed to carry out the analysis for the fund managers and mainstream analysts to use;
q Engagement with investee companies is needed. Both governance and responsibility engagement can be assessed with identical questions. (But often with quite different results.)
There are 10 scaled criteria for each of the following:
q The manager's leadership and culture;
q Integration of governance and responsibility issues into the investment process;
q Engagement with investee companies on governance
q Engagement with investee companies on corporate responsibility.
To assess leadership and culture we are looking for:
q A supportive attitude from top leadership;
q Appropriate reporting lines for the specialists in governance and responsibility matters;
q Assurance and learning with regard to this development being sought internally;
q Recognition of this development in the appraisal, reward and career progression processes;
q Adoption of good governance and responsibility in the manager's own internal operation;
q Evidence of these developments in the manager's product offering and in reporting to clients.
To assess integration into the investment process we are looking to include:
q The decision-making process to involve specialists in governance and responsibility matters, have ready access to relevant research, have front-office champions for this development, and be facilitated through training of both front-office and specialist staff;
q Adequate resources including, broker and strategist research, specialist staff;
q Ability to deal with conflicts of interest.
To assess engagement with investee companies, we are looking for:
q An engagement policy including setting priorities and effectiveness of engagement including, setting objectives and evaluating results for each engagement, evidence of depth and persistence of engagement, assertiveness in dealing with investee companies, and the ability to collaborate with other investors;
q Resources including, use of specialist research and use of in-house specialists;
q Scope of engagement which is not restricted to the larger UK listed companies.
The graded questions give visibility and objectivity to this inquiry. Results are presented to the manager in the form of graphs in summary form and for each question.
In this way, we can say quite specifically, where there are shortcomings with respect to other managers and thereby encourage development in the right direction.
This exercise has been carried out for all of USS's investment managers and is built into the selection process for new managers, but in a more compressed style.
We have received the following results:
q Managers find this a learning experience because this depth of inquiry in this area is quite unusual;
q The response of managers has been generally pleasing, although it is too early to comment on the extent of progress which is being made;
q We have found quite wide variations in individual manager's capability in the different areas.
For example, a manager may provide a model for how engagement on corporate governance matters should be carried out, but pay virtually no attention to the other aspects;
q Between managers there is a wide spectrum of overall capability with some managers being quite advanced in most areas and other managers only just starting out with this development.
The incorporation of these considerations in the wider environment, for example in the availability of research which incorporates these considerations from stockbrokers, is limited at present, although there are one or two brokers who are producing good quality research.