The latest Jericho roundtable discussion on behalf of Federated Hermes looks at reforms that might be necessary to our financial – and specifically investment – sector to serve the common good.
If you would like to be involved in the programme, please get in touch.
Although it is currently taking quite a reputational battering, free-market capitalism is one of humanity’s greatest inventions and the greatest source of prosperity the world has ever seen. However, we can now see that, for all its undoubted benefits, this success has been costly. Capitalism has been rapacious and is on the verge of spoiling our planet and destabilizing society as wealth rushes to the top. The time for action is running short.
The argument that the sole purpose of business is to make money and maximize shareholder value was made forcefully by Milton Friedman fifty years ago this month in a famous New York Times article. The Nobel prize-winning economist argued that maximising profits within the law was the sole duty of company directors. Any other responsibility or target was a distraction and ended up with shareholders, customers or employees contributing against their will to causes favoured by the Board.
There are very few flag-waving Friedmanites putting their heads above the parapet these days. (And if they did the flag would be white.) Even before COVID there were widespread attempts to reimagine capitalism so that it is not only an engine of prosperity but also a system that is in harmony with environmental realities, striving for social justice and the demands of truly democratic institutions.
The pandemic has thrown into sharp relief many of the failures of the current model, including the role the asset management industry plays within the system. These shortcomings were, of course, already under the microscope, pre-COVID. While the future remains uncertain, it’s clear that the asset management industry has a crucial role to play in capitalism’s reset.
This process is well underway in the eyes of some in the investment community. “Responsible investment” funds attracted £966 million of new client money in the UK in July, more than half the net £1.6 billion of total inflows. Who, indeed, wishes to invest, or be seen to invest, in something “irresponsible?” But, as a Times business columnist noted recently: “Does society really want the actions of business shaped by what many fund managers privately regard as no more than a fabulous marketing wheeze?” It is high time for clarity about what is meant by “responsible.”
Too often, firms shelter behind a compliant, tick-box nod to ESG considerations – this is unlikely to prove sufficient to deliver a prosperous economy which benefits all of society. Others argue that while this is a first step, more fundamental structural and behavioural change is needed in the industry. “Purpose” needs to be far more than a new branding device which is handed to the marketing department to develop and milk for beneficial corporate effects.
Moreover, as corporate belts tighten in light of the economic downturn, will the ambition to realign the needs of society with the responsibilities of business be set aside in favour of the inevitable demand of growth rebound?
This was the broad ground of a discussion recently organised by Jericho Chambers on behalf of Federated Hermes to explore not just where we are now, but where we go next: threat or opportunity for genuine reform?
Responsible Asset Management: Future Thinking
The conversation was opened by Federated Hermes CEO, Saker Nusseibeh. “Current models of investment management are ripe for disruption,” he said. “New thinking, new practice and new leadership behaviours may be required if we are to ‘Build Back Better’. So how can the investment industry change to meet the interests of investors who together make up the society in which we live?
“Our role is to properly steward other people’s wealth – not use that wealth as a vehicle for self-aggrandisement.”
“First, as an industry we must put the investor and society at the heart of everything we do and adopt sustainable wealth creation as our purpose. This means a change in attitude, culture and behaviours of the firm. Our role is to properly steward other people’s wealth – not use that wealth as a vehicle for self-aggrandisement. Responsibility and purpose are where we end up – not where we start. Sustainability is not there just in terms of money but the whole of society.
“Second, investment should not be a cover for trading. Buying and selling is not investment. Nor is hugging the benchmark. The approach we take at Federated Hermes combining (1) high active share, (2) integration of ESG alongside traditional factors and (3) stewardship is what we understand by investment. Passive investing with proper meaningful stewardship has its role to play. Professional poker players would have better hit ratios than the best traders. But we don’t go to Las Vegas to make our hires.
“I think asset management has been reduced to an heuristic – to provide a dividend stream for owners to enable members to retire better.”
“Third, for investments to be sustainable, there must be a real partnership between the investors, the investment, the customer served, the staff employed and the society and environment. This goes beyond the transactional – each has to respect the other and want the other to succeed. I think asset management has been reduced to an heuristic – to provide a dividend stream for owners to enable members to retire better. We can no longer accept the silo system which holds that we have a financial system where asset managers live and work: an economy which is the province of the government and then society in which we all live. They are all the same. So stewardship must be about far more than simply voting at the AGM.
“Fourth, as an investment house we have to govern ourselves to be completely aligned to the investor. This has implications for our boards, the way we assess the performance of executives and staff and remunerate them, fee structures, how and what we report on. We need to remember ‘physician heal thyself.’ Every function and department in an investment house should have stewardship in its widest sense as its guiding principle.” Saker acknowledged the scale and humility of his organisation’s journey: “We see ourselves as a little pebble falling down the scree. Others may follow and I hope they do.”
A New Covenant
For two fresh but startlingly different remedies for late-stage capitalism’s woes, we went to a business school professor and a non-Corbynite Labour peer. Maurice Glasman, a member of the House of Lords and creator of the “Blue Labour” movement, was undaunted by advocating huge societal change. He called for no less than a new societal covenant to replace free-market capitalism.
“Nature is not a commodity to be exploited at will but an inheritance. Neither are human beings straightforward commodities.”
“We are at an inflection point, a change of era that precedes COVID,” he argued. “We have watched unfettered globalisation lead to a huge rise in the free movement of money, services, goods with little accountability. Nature is not a commodity to be exploited at will but an inheritance. Neither are human beings straightforward commodities. You could define populism as an attempt to protect human status in an inhuman system.”
Indeed, he observed, “We’ve seen during the pandemic what might be a new definition of ‘the working class’ as people who cannot do it from home but have to leave the house”. This, he predicted, would give them a rightful new sense of agency.
Maurice wanted a transformation away from the idea of contract – an immediate exchange of equivalence between hands – to a new covenant: an idea of long term binding relationships between generations, classes, regions and tribes in which assets were not entirely owned but “acting for a common good over time.”
This is nothing if not hugely ambitious. But he felt that the “extremely strong concentration of ownership of capital” must change because it was “disintegrating society.” There was no longer “reciprocity or give and take” and far more “beneficial constraints” on capital were required.
Acknowledging that his was a big ask, Maurice had a number of practical, remedial suggestions: firstly, association of interests locally, nationally and internationally; secondly, a de-concentration of capital from London to regional areas and the establishment of banks in sectors of the UK ‘denuded of all financial institutions’; and thirdly the conversion of some universities into vocational institutions to help employment prospects for the young and re-establish trust between the generations.
Growing The Pie
The second provocation came from Alex Edmans, Professor of Finance at London Business School and the author of “Grow The Pie: How Great Companies Deliver Both Purpose and Profit.” Alex invited the group to consider the company Vodafone. He cited two actions taken by the company in the last two decades. The first was M-Pesa, the revolutionary method of transferring money by mobile phone message which has proved a huge success across Africa. Citing the example of a Kenyna goat herder who no longer had to travel on foot for a day to bank money, Edmans pointed out that M-Pesa had taken 200,000 Kenyan households out of poverty.
The second was Vodafone’s 2012 “tax transparency report” which highlighted to those who were interested, what corporate tax payments Vodafone was making and where across its many territories. Edmans asked a simple question. Which of these two decisions created most value to society?
“The problem with our current system, he argued was that “You don’t get into trouble for not creating value.”
A bad ESG rating and reputational damage were one thing but the positive value of M-Pesa was of a different order. The problem with our current system, he argued was that “You don’t get into trouble for not creating value.”
Responsible business he suggested should, of course, behave responsibly but not just seek to do no harm. The positives need to be accentuated and indeed sought out. Business is there to use excellence and innovation to improve the general lot. That is its purpose even in ways that might not create short term profit but achieve something greater if given time.
Beyond Creative Destruction: Re-Enfranchisement & New Mandates?
This seems to be an acknowledgement of Joseph Schumpeter’s “creative destruction” contention that entrepreneurs play a decisive role in the economy by creating and implementing radical innovations that are conducive to economic progress. It is this spirit which is the lifeblood of healthy capitalism.
Sally Bridgeland, Independent Member of the Nesta Trust Investment Committee, built on Alex’s point by questioning when ESG factors were reduced to avoiding risk – a negative – rather than actively making things better. Ticking the rights boxes rather than using the power of the corporate brain to be innovative. “Far too often one sees R&D budgets getting trashed and the experience of profits and dividends,” she said.
The degree to which end users of the pension world – the customers who wish a decent pot on which to retire – could and should influence the behaviour of the company assets their pension funds own was a key question that needed addressing.
Sarah Bates, the chair of the John Lewis Partnership pension fund said: “I worry that our industry is perceived as if it knows what is good for people. Big assets owners rarely have engagement. Savers are atomised. They are on their own. They cannot vote.”
Lesley Alexander, Vice President of the Pensions Management Institute agreed: “Pension members are disengaged and disenfranchised. They feel what happens just happens to them. We’ve failed to capture their imagination when it comes to such important decisions. They have a vital stake in society. And it’s a society that now requires a radical re-think.”
John Kay is one of the UK’s leading economists and author of two new books Radical Uncertainty and Greed Is Dead. He wasn’t sure he completely agreed with Sarah and Lesley. “I think urging greater involvement by members of a savings or pension scheme can be a chimera. I don’t have deeply researched views on Airbus and Vodafone and what they do every day. I wonder how much ordinary people care. Certainly, I want to feel they are “good” companies run in a professional way by competent management. Making sure this occurs is the job of asset managers – it’s not an all-in democracy.”
What is now true is that there is growing evidence that ESG does not hurt performance. Mounting numbers of investors are switching their core passive holdings over to ETFs that track sustainable indices. But these funds are not without their limitations. One hitch with sustainable indices is they rely on rating agencies like MSCI to grade companies on their ESG performance, and those scores are largely subjective. What gets measured may well get managed but active and selective ‘management’ of data to demonstrate virtuous behaviour and game indices is widespread. The rules on the playing field aren’t not universally agreed.
Conclusions – and What Next?
It’s true that “stakeholder capitalism” — where employees, suppliers and the future of the planet are just as important as shareholders – is here to stay. But this does mean that company bosses and those funds with stakes in those companies now have to navigate a much more difficult landscape. Profit maximisation did have one virtue – it was simple to understand and shoot for. Poker players and their zero sum games would find the complexity of the new environment difficult to manage. The old ways also imposed a discipline of a sort. How much weight modern-day managers are supposed to give each of the multiple goals they are now expected to pursue is a subject that requires far deeper investigation. However, one fact remains inescapable – there will be no profits to maximise on a dead planet.
As Federated Hermes, supported by Jericho, continues to develop this thinking we invite experts and interested individuals from across the financial spectrum to get radical with practical solutions, looking at the following core questions:
- Sustainable Wealth Creation
What is required to shift the economy’s mindset to properly consider the need to deliver fair returns to all stakeholders? How should the industry ‘break the tragedy of horizons’?
- Next Generation Fiduciary Expectations
What are the economic and societal outcomes which are critical to achieve sustainable wealth creation and how can the investment management industry be accountable to them?
- Structural Change
How can client mandates, fees and governance, including pay within the industry, be better aligned towards sustainable wealth creation? What should the role of stewardship be in an investment house alongside investment activities? What regulatory changes might be needed to achieve this?
- Overcoming Systemic Barriers
Signalling versus impact – what is the role of engagement versus exclusions and divestment in the active and passive spaces?
- Collaboration in the Investment Chain
How can different industry players work together to further investors’ and society’s long-term interests? How do incentives need to change to allow this? What are the roles of the debt, equity and private markets in driving rapid and relevant change?
- Exercising Leverage
How can the power of individual savers be harnessed most effectively to effect change by and in the investment industry?
The discussion was attended by:
- Lesley Alexander, Vice President of the Pensions Management Institute
- Sarah Bates, Chair, JLP Pension fund
- Sally Bridgeland, Independent Member of the Nesta Trust Investment Committee
- Alex Edmans, Professor of Finance, London Business School, Author, Grow The Pie
- Maurice Glasman, Labour peer, Common Good campaigner, originator of the “Blue Labour” movement
- Matthew Gwyther, Partner, Jericho Chambers
- Leon Kamhi, Head of Responsibility, Federated Hermes International
- John Kay, Economist and Author
- Martin Mannion, Head of Trustee Services, John Lewis Partnership
- Saker Nusseibeh CBE, CEO, International at Federated Hermes
- Rebecca O’Connor, Co-founder, Good with Money
- Robert Phillips Founder Jericho Chambers
- Dr Anna Tilba, Associate Professor in Strategy and Governance, Durham University Business School
- Jane Welsh, Senior Investment Consultant, Diversity Project
- Charles Wookey, CEO, A Blueprint for Better Business
- George Wright, Assessment Manager, Banking Standards Board