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Guiding light of shareholder value

When you think of Sweden, you think ‘green’ – environmentally friendly, clean and responsible.
The Swedish pension fund world is no exception. Consider AP7’s high profile stock-screening policy based on international corporate social responsibility (CSR) guidelines. At the root, however, the debate between CSR, shareholder value and the role of the pension fund is no different than anywhere else in Europe.
Pernilla Klein, communications manager at the e13bn Trejde AP-Fonden (AP3) says the fund’s position as a quasi government entity, created in its present guise under the AP fund law in 2000, meant that there were certain guidelines AP3 had to follow, although as Klein explains: “There was a stipulation in the law that there should be a policy within the AP funds on corporate governance, although it doesn’t go any further than that.
“There is also part of the law, which says that AP funds should take environmental and social considerations into account without relinquishing the overall goal of returns on investments and we spent some time looking into what this would mean.”
AP3 certainly had some peer comparisons close to home.
The fourth AP fund had been active for some time in the area of corporate governance, adopting the first governance code in Sweden back in the early 1990s.
AP3 adopted its first Corporate Governance Policy in 2000 when the fund was set up according to the new AP-fund law – a policy that was updated in 2002 and is being further revised this year. It focuses on a strategy that puts shareholder value at its centre: “You could say that our approach is this: making sure that the board and management are working in the best interest of the shareholders,” says Klein.
The fund currently invests 54.5% of its assets in equities, of which 30% is invested in Sweden and the rest overseas. Around 90% of the fund is managed actively and a large portion of the assets is managed internally.
For the time being, Klein notes that governance issues are focused on the fund’s Swedish holdings only: “Essentially this is because Sweden is where we have our biggest stakes in companies – often around 1-3% of capital. “Also this approach should be seen in the light of the fact that Swedish corporate governance practices are slightly different than European or Anglo-Saxon practices.”
However, she points out that the fund is certainly aware that much of its domestic governance policy is applicable globally, adding that AP3 is working on a global corporate governance policy to guide its external asset managers when carrying out proxy voting.
In terms of what the fund actually stipulates in its governance approach, she notes that one of the main tenets is that executive stock options should be expensed in the profit and loss statement of investee companies.
“To date, no Swedish companies have decided to do this, as opposed to the US where this is quite an issue and where there are large numbers of S&P500 companies that have agreed to do so.”
Additionally, the fund also believes that stock options should be performance based. Says Klein: “This is possible in a variety of ways, but management shouldn’t just be rewarded because the stock market goes up, there has to be outperformance of the corporation – whatever way you measure that. You could for example compare the stock price with the company’s sector peers.”

Another issue the AP3 fund votes on is its belief that all board members should be shareholders, an issue that it has actually raised in a number of AGMs for companies in Sweden where this is not the case.
“Another area we also stress is independence of the board from the corporation management. Best practice in Sweden is that one member of the main board should be independent in that they are not dependent on the company. However, in Sweden we don’t have a tradition of executive directors and the board is representative of the owners, which we think is the way to do it. Consequently, we don’t believe that the CEO should sit on the board, which is still the case with many companies in Sweden today. While we don’t actively work for the CEO resigning from the board, in the case of a new CEO being appointed we have actively been involved in five or six cases where we lobbied for the CEO not to do this. So far we have not get acceptance but we are going very public with this. It’s a long struggle but I think you have to start somewhere in trying to change the culture.”
Another area where AP3 is seeking change is the ratio of differential voting rights, which the fund feels has become too wide in Sweden. “Ownership of companies is dispersed and globalised today, but you need to have a clear idea of who owns the company.
“We believe differential voting rights should remain, but within reason, because we do want real owners of the companies with a personal stake in its future. It’s a question of long-term investment.”
The SRI strand of the fund’s engagement strategy, Klein explains, was somewhat harder to decide on. When the fund looked at how or why it might implement an ethical-based programme, they were faced with the choice of negative screening or best-in-class approaches, amongst others – none of which, she points out, could the fund justify on an objective basis.
“We interpreted this in the following way. This is not a retail fund that has certain criteria that can be communicated effectively to those who buy into it. The AP funds represent everybody in Sweden. Nine million inhabitants put their money in and they have no choice in doing so, the money goes in automatically. This means that there’s a very special obligation for us and our approach has to have a national consensus to it.”
AP3 finally decided to avoid negative or positive stock screening. “We felt there was a lack of consistency and no universal consensus on the criteria being used. Attempts to rank companies are very subjective – you just have to compare the Dow Jones Sustainability Index and the FTSE 4 Good! As a state authority, however, we really have to be objective.”
Instead, the fund concentrated on an engagement approach, which Klein notes took much inspiration from the trend seen in the UK.
“The question we ask is whether management is identifying, controlling and managing its identifiable business risk – meaning CSR – in a way that maximises value.
“We’re not getting into the stakeholder concept or triple bottom line or whether the goal of the company is to maximise the benefits for society or sustainability. We really think we are only legitimate in working with shareholder value.
“We looked at AP7’s method and we think it is a serious attempt to screen out companies on the basis of international conventions. We have respect for their approach but we don’t feel that it is consistent enough for us.”
The engagement line, Klein says, focuses on material, environmental and ethical concerns that company might be faced with, such as material procurement in countries with oppressive regimes, or substandard environmental policies at the company.
“If there is any CSR risk then the company should have a corporate code of conduct to address the issue. This is becoming best practice worldwide. For the environment, they should have quality standards such as ISO14001 on the social/ethical side they should have a human rights code and a policy against bribery.
The second focus, Klein adds is transparency of reporting on these issues and compliance. “We encourage companies to follow the Global Reporting Initiative, for example.”
Using UK-based CSR agency, CoreRatings, the fund receives information on the 70 or so companies in its Swedish portfolio.
On top of that, AP3 draws up a focus list of 10-15 companies where its stake exceeds 3%. “With these firms we feel we have a special responsibility as we might be the largest shareholder.
“CoreRatings then helps us to identify companies in our Swedish equities portfolio which should improve their management of CSR-risk, in order to enhance value for shareholders. On this basis, we tend to have serious dialogue with about three to four companies per year, backed up by CoreRatings and I think companies are willing to respond to this given that CoreRatings have a view as to what is best-practice globally.”

At present, internally managed non-domestic equity holdings are not voted on, but Klein says AP3 is looking to see what it can do in terms of introducing a global corporate governance policy and possibly hiring a voting agency or an asset manager to vote by proxy, or even implementing something internally.
“This is a problem today because equity portfolios are globalised and managed externally and asset managers a lot of the time don’t care too much about proxy voting and corporate governance in general. There are a lot of AGMs where only 20-30% of the votes are represented and the foreign owners are not there!”, she says.
“Managers are becoming more aware though of client concerns in this area and certainly we are one of the buyers putting pressure on them.
“I hope we will get the global governance policy in place before the end of the year. It will be a kind of blueprint where we can say on these issue we will vote against, on others we will vote for and others we will abstain, because it has to be feasible for the managers to put this into their systems. We’re not going to vote on every issue because we hold something like 2,000 companies worldwide!”
Overall, Klein believes that AP3’s strategy of a shareholder value focus on a confidential dialogue basis gets results. “If we don’t agree with the company or get a satisfactory outcome then we may look at the issue again differently, but I think you get a better working environment this way.
“Everything boils down to shareholder value. We’re not politicians, we’re just investors.”

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