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The New Focus for Global Investors: Responsible Investment and Active Share Ownership
26th September 2006
The Hermes Group operates through a variety of separate and distinct legal entities, including Hermes Investment Management, Hermes Focus Asset Management and Hermes Property Asset Management. Issued and approved by Hermes Investment Management Limited, authorised and regulated by the Financial Services Authority.
CIBC Centre for Corporate Governance and Risk Management
Colin MelvinChief Executive, EOS
www.hermes.co.uk
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Agenda
Introduction
Best Practice in Responsible Investment
– Institutional Shareholders’ Committee Statement
– ICGN Statement of Principles on Institutional Shareholder Responsibilities
– UN Principles for Responsible Investment
Responsible Investment in Action: Hermes Equity Ownership Service
Conclusion
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Introduction to HermesAligned with pension fund goals and objectives
Hermes is unique in the investment industry
Independent investment manager of c.£63bn*. 3rd largest Pension Fund Manager in UK**
Hermes is the ‘executive arm’ of the largest UK pension scheme, the British Telecom Pension Scheme
Heritage and ownership aligns Hermes with long-term orientated pension funds and other investors
Performance is the key - not asset/revenue growth driven
* As at 30th June 2006 Source: Hermes ** Source FTFM Survey 05/06/06
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Issues for Trustees as equity investors
STEWARDSHIPSTEWARDSHIP PERFORMANCEPERFORMANCEMEMBER MEMBER AWARENESSAWARENESS
TIMETIME SINGLE ISSUE SINGLE ISSUE ACTIVISTSACTIVISTS
FUNDINGFUNDING
LEGISLATIONLEGISLATION/ REGULATIONREGULATION
DISCLOSUREDISCLOSURE
Stewardship is central to the Trustees’ role
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Practical
Hermes Focus Funds outperformed since inception
CalPERS“Corporate Governance has been best alpha driver over last 5 years, 2000 – 2004” – Mark Anson, former CIO
Relational Investors LLC (US) outperformed by 6.3% per annum *
Academic
LBS “Shareholder Activism in the UK - A Clinical Study” ** found value created through shareholder engagements
Gompers found a fund taking long positions in top decile Governance ranked companies and short positions on bottom decile would have outperformed the market by 8.5% p.a. throughout the 1990s ***
Deutsche Bank research shows a positive relationship between historic governance assessment and profitability (ROE) ****
Stewardship, Value and Engagement – Overview
Investment in stewardship adds value
*see Appendix 1
** London Business School (2006)*** Gompers et al (2004)**** Deutsche Bank (2004a), (2004b), (2003)
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Best Practice in Responsible Investment
Institutional Shareholders’ Committee Statement
ICGN Statement of Principles on Institutional Shareholder Responsibilities
UN Principles for Responsible Investment
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Best Practice
Statement of responsible investment policy
Monitor performance of and have dialogue with investee companies
Intervene where necessary
Escalate intervention on a case-by-case basis
Evaluate impact of responsible investment activity
Institutional Shareholders’ Committee
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Best Practice
Institutional shareholders have internal and external responsibilities
Understanding the chain of ownership
Dealing with conflicts of interest
Responsibilities with respect to companies
The benefits of good internal governance
ICGN Statement of Principles
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United Nations PRI objective
To develop and implement a set of global principles that facilitates the integration of environmental, social and governance (ESG) issues into mainstream investment practices
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June/July 2004 – Klaus Toepfer of UNEP announces Principles for Responsible Investment process in London and UN Global Compact publishes first "Who Cares Wins" report.
April 2005 – First PRI Expert Group meeting in Paris.
June 2005 – UN Secretary-General Kofi Annan convenes first PRI Investor Group meeting at UN Headquarters, New York. 21 asset owners representing USD 1.7 Trillion. Subsequent meetings in Toronto, London, Boston.
April 27/ May 2 2006 – UN SG Annan rings bell and opens NYSE. PRI launched supported by 34 asset owners and 18 investment managers from nine countries representing more than USD 4 Trillion.
UNPRI Timeline
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Preamble
“As institutional investors, we have a duty to act in the best long-term interests of our beneficiaries. In this fiduciary role, we believe that environmental, social, and corporate governance (ESG) issues can affect the performance of investment portfolios (to varying degrees across companies, sectors, regions, asset classes and through time). We also recognise that applying these Principles may better align investors with broader objectives of society. Therefore, where consistent with our fiduciary responsibilities, we commit to the following:”
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The Principles
1. We will incorporate ESG issues into investment analysis and decision-making processes.
2. We will be active owners and incorporate ESG issues into our ownership policies and practices.
3. We will seek appropriate disclosure on ESG issues by the entities in which we invest.
4. We will promote acceptance and implementation of the Principles within the investment industry.
5. We will work together to enhance our effectiveness in implementing the Principles.
6. We will each report on our activities and progress towards implementing the Principles.
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Best Practice
Statement of responsible investment policy
Monitor performance of and have dialogue with investee companies
Intervene where necessary
Escalate intervention on a case-by-case basis
Evaluate impact of responsible investment activity
EOS
Hermes Principles
Vote all shares
Discussion with companies
Inclusion in core engagement programme where future intervention is required
Intervention on basis of formal proposal approvedby Responsible Ownership Committee
Regular meetings with directors
Work with other investors as appropriate
Public vote is last resort
Contact and actions recorded
Report progress to clients on regular and ad hoc basis
Best Practice and Hermes Equity Ownership Service
EOS represents best practice for responsible investors
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Equity Ownership Service and Responsible Investment
Engagement designed to enhance value
– Proprietary screening system
– Identifies potential for improvement in long term value
Intelligent voting
– Vote all holdings in all markets (where possible)
– Voting rational communicated to companies
– Lever for change
Global coverage
– Over 3,500 company meetings worldwide
Comprehensively address the needs of fund fiduciaries
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Additional investment and engagement
on strategic issues etc
Focus Funds
Inte
nsi
ty o
f in
volv
emen
t
All Companies
Contact driven by company consultation (on pay and other issues)
Overview of EOS Activities
Government and regulatory engagement to ensure best possible backdrop for shareholder rights
High
Low
Core engagement on strategic,
capital structure issues etc1
‘Tier 1’ engagement
Engagement on structural governance Board structure
Pay
Succession planning
Social, ethical and environmental issues
‘Tier 2’ engagement
Voting activity, related discussions, letters and meetings
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Equity Ownership Service – Process
Effective controls
– Senior Hermes staff involvement (CEO, CIO)
Integrated approach
Fund Managers EOS Focus Funds
Rigorous monitoring and assessment
– Financial evaluation
– Engagement trail maintained on database
A process designed to protect clients’ interests
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Equity Ownership Service – People
Unrivalled resource
– Over fifty people directly involved in governance and engagement
Comprehensive skills
– Team includes a blend of skills from business strategy, consulting and investment banking. Allows engagement from position of knowledge and understanding
Governance expertise
– Team includes some of the industry’s foremost governance experts
Ownership culture
– We act on our clients’ behalf as an owner rather than a service-provider
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What EOS Provides to Pension Fund Trustees
Insight Hermes’ knowledge, expertise and advice Reporting on activities and engagement Feedback on market developments
Control Retain ultimate voting control of your shares Ability to initiate engagement on your issues Input to direction and development of EOS
Access Dedicated relationship manager Regular formal and informal communication Regular meetings
Value Activities designed to add economic value Alignment with fiduciary duty Engagement on financially material issues
EOS
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Responsible investment is linked to corporate value
Conflicts of interest in the chain of ownership can impede accountability and the effectiveness of investors
Nevertheless, active share ownership represents a new focus for global and local investors
Conclusion
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Appendices
1. Shareholder Engagement Funds’ Performance
2. Stewardship Staff
3. Case Studies
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Shareholder Engagement Funds
• Launched October 1998
• Investment universe: FTSE 350
• FUM(1)
£977m
• Managed by Hermes Focus Asset Management Ltd
(2)
• Launched February 2002
• Investment universe: European stocks (European Economic Area ex-UK, plus Switzerland)
• FUM(1)
€1.5bn
• Managed by Hermes Focus Asset Management Europe Ltd
(2)
• Launched March 2002
• Investment universe: UK companies outside FTSE 350 (ex-Investment Trusts Index)
• FUM(1)
£143m
• Managed by Hermes Focus Asset Management Ltd
(2)
• Relational investors LLC formed in 1996
• Investment universe: US listed stocks with equity market capitalisations in excess of $1bn
• FUM(1)
$6.2bn
• Managed by Relational Investors LLC
(1) Funds under management as at 30/6/06(2) Relational Investors LLC (“RILLC”) is a Registered Investment Adviser in the USA. RILLC and Hermes Focus Asset Management Limited (“HFAM”) have a strategic marketing alliance. HFAM does not have an ownership interest in RILLC and RILLC is fully independent of Hermes. This Fund has reached its capacity and is currently closed to new investments.
Nissay Hermes Stewardship Fund
Rel
atio
nal I
nves
tors
LLC
(3)
European Focus Fund
UK Small Companies Focus Fund
UK
Focus Fund
• Launched March 2005
• Investment universe: 550 Japanese listed stocks
• FUM(1)
¥32bn
• Managed by Nissay Asset Management Corporation
• Advisors: Hermes Focus Asset Management
(2)
Appendix 1
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9.4%
11.4%11.0%
9.8%
7.3%
6.1%
1.1%
3.9%
3.1%
0%
2%
4%
6%
8%
10%
12%
Hermes UK Focus Fund Hermes European Focus Fund Hermes UK Small Companies Focus Fund
Absolute Fund Performance
Benchmark
Relative Performance
(1) UK Focus Fund benchmark is FTSE All Share Total Return Index (2) European Focus Fund benchmark is FTSE World Series Europe (ex UK) Total Return Index(3) UK Small Companies Focus Fund benchmark is FTSE Small Cap (ex Investment Trusts) Total Return Index(4) All performance figures are annualised and relative performance is calculated on a geometric basis
Per
form
ance
(p
.a.)
(launched 1 October 1998) (launched 25 February 2002) (launched 4 March 2002)
(1) (2) (3)
Focus Funds in PractiseThe Focus Funds’ performance has been positive, supporting our view that good ownership adds value
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28.6%
12.4%
5.7%
26.4%
6.3%
1.7%0%
5%
10%
15%
20%
25%
30%
35%
Nissay Hermes Stewardship Fund Relational Investors LLC
Absolute Fund Performance
Benchmark
Relative Performance
Annualised Investment Performance Since Inception for other Hermes-related Shareholder Engagement Funds
(1) Nissay Hermes Stewardship Fund benchmark is TOPIX(2) Relational Investors LLC benchmark is S&P 500(3) Relative performance is calculated on a geometric basis
Per
form
ance
(p
.a.)
(launched 1 July 1997)(launched 16 March 2005)
(1) (2)
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EOS Provided by Team with Unparalleled Experience and Ability
David Pitt-Watson, Chairman20+ years strategy: ex-co founder & MD, Braxton/Deloitte
Colin Melvin, Chief Executive12 years governance experience; ex-Baillie Gifford, Standard Life
Paul Munn, Commercial Director
9 years PLC Board experience; ex-CEO Dawson International
Paul Lee 5 years governance and English law
Makoto Seta9 years professional experience; ex-Arthur Andersen
Karin Ri7 years professional experience; ex-Morgan Stanley; Nomura
Jennifer Walmsley5 years professional experience; former journalist
Ian Greenwood
5 years professional experience; ex-NAPF; RREV
Elena Tedesco5 years governance; ex-Deminor
Hans Hirt4 years professional experience; English and German law
Hege Sjo
9 years professional experience; ex-CFO Norwegian Börs
Bess Joffe4 years professional experience; lawyer; ex ISS Canada
Naheeda Rashid2 years governance; ex-Baillie Gifford; RBoS
E
O
S
PLC Board experience:
John Leach 30+ years: ex-CEO Brent WalkerPaul Harrison 10 years: ex-CEO Hi-Tech Sports
Additional support from:
Mark Anson CEO, HermesTony Good ex- Norwich UnionMike Bishop ex- MorleyMike Connors ex Barclays & Fleming
Senior strategy consultancy experience:Wouter Rosingh 20+ years: ex-Director, Booz Allen HamiltonLeon Kamhi 15 years: ex-Braxton/Deloitte
Investment experience:
Mike Weston 14 years: ex-Merrill LynchMarco Ricci 14 years: ex-DeutschePhil Harris 14 years: ex-Credit SuisseNigel Davies 17 years: ex-West LB
Other experience:
Corinna Arnold 14 years corporate governance & institutional relations Tim Bush 12 years accounting and public relationsMark O’Connor 12 years investor relations & marketing
Corporate finance experience:
Stephan Howaldt 16 years: ex-Warburgs, Siemens Corporate
Appendix 2
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Case Studies
Hanson
BAE Systems
Premier Oil
Appendix 3
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Background
Board in need of refreshment and renewal
Management appears overly focused on financials to the apparent detriment of operational efficiency
Capital structure inefficient with insufficient debt
Non-core businesses dragging down returns and distracting management
Unclear whether there is value-added from combining aggregates with building materials (particularly brick) businesses
Engagement Issues
Encourage board change, particularly succession to the chair
Encourage focus on operational effectiveness, if need be by changing management
Ensure that buybacks are restarted to increase debt/equity ratio
Consider sale of non-core businesses in Asia-Pacific and continental Europe
Test management thinking regarding a possible sale
Case study – Hanson
Engagement addresses strategy
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1 21 Sep 04 Meeting with new non-executive (and possible future chair) on succession, capital structure and strategic issues
2 27 Sep 04 Meeting with SID Simon Keswick on succession, capital structure and strategic issues
3 15 Oct 04 Share buyback programme restarted
4 17-24 Nov 04 Discussions with Simon Keswick on potential candidates for the chair role
5 15 Dec 04 Discussion with chairman Christopher Collins, taken inside on succession decision
6 17 Dec 04 Announcement of succession to chair
7 11 Jan 05 Meeting with outgoing chair Christopher Collins
8 19 Apr 05 AGM, departure of Collins and two other long-standing non-executives, appointment of Mike Welton as chair
9 20 Apr 05 Strategy presentation afternoon, with intensified focus on operational efficiency
10 04 Aug 05 Meeting with management to discuss strategy, capital structure and operations
Case study – Hanson (cont’d)
Chart dates from 1 July 2004 to 4 August 2005
Source: DATASTREAM and Hermes Investment Management Ltd
3
4
67
89
Q3'O40.32
0.34
0.36
0.38
0.40
0.42
0.44
0.46
0.48
0.50
0.52
Q4'04 Q1'05 Q2'05 Q3'05
Hanson Hanson Relative to the FTSE Europe Construction & Building Index
21
10
5
Managing investments to create value
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Background
Public breakdown of key client relationship with MoD following problems with Astute and Nimrod contracts
Governance: Board dominated by executives, particularly with a long-serving
executive chair and executive vice chair
Lack of transparency and so market confidence in management and the company
Concern that intended to merge into US rival at undervalue, before solved own problems
Engagement Issues
Encourage board focus on rebuilding key relationships, without involving press
headlines
Improve transparency and rebuild confidence following Nimrod and Astute failures
We expected that these aims would require a significant reshaping of the board
Ensure solved own problems before rushing into any substantial deal
Case study – BAE Systems
Engagement addresses board renewal
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Managing investments to create value
2003 2004 2005100
120
140
160
180
200
220
240
260
280
10 Feb 03
Ensured could speak for investors holding c15% of the shares
11 Feb 03
Phone conversation with Sir Robin Biggam, SID
14 Feb 03
Follow-up letter which was shared with the board
20 Feb 03
Significant board changes announced and follow-up meeting with Sir Robin
6 Mar 03
Meeting with executive management
24 April 03
Meeting with Sir Peter Mason, chair of nominations committee, on requirements for next chair
1 May 03
Facilitated meeting with Sir Peter for 10% holder
14 July 03
Meeting with Michael Hartnall, chair audit committee
H2 03
Ongoing contact with Sir Peter to reinforce comments
24 Mar 04
Announcement of Dick Olver, former BP deputy CEO, as next chair of BAE
24 June 04
Meeting with Dick Olver to agree agenda
1 July 04
Olver takes over as chairman
7 Mar 05
Announcement of acquisition of United Defense industries for £2.2bn
PRICE
PRICE REL. TO FTSE ALL SHARE - PRICE INDEX
Source: DATASTREAM/Hermes
Case study (cont.) – BAE Systems
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Background
Capital structure: two dominant shareholders(each 25%) and overburdened with debt
Governance: Six of eight non-executives notindependent
Risk management: largest UK investor in Myanmar (Burma)
Strategic: locked into mature assets, notlightweight explorer where could have competitive advantage
Long-term share price underperformance
Engagement Issues
Find route to give company independence from dominant holders as intended strategy now abandoned; cut debt
Remove some, add new independent directors
Justify the risk taken by being present there, or exit the country
Exit mature assets, slim down and refocus on fleet-of-foot exploration and production activities
Improvement to come from addressing agenda issues above
Case study – Premier Oil
Engagement addresses CSR and its value impact
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Case study (cont.) – Premier Oil
22/7/03
PRICE REL. TO FTSE ALL SHARE - PRICE INDEX
Source: DATASTREAM/Hermes
Managing investments to create value
PRICE REL. TO FTSE OIL & GAS SECTOR
2000 2001 2002 200310
15
20
25
30
35
40
45
50
29 June 00First face-to-face discussion with companyon risk management
26 Oct 00First meeting of group offund managers and campaigning groups
9 Jan 01Constructive first meeting with chair, Sir David John
16 May 01 AGMPublic acceptance that two major holders weigh on share price
18 Oct 01 EGMAgreement to slim down asset base
19 Dec 01Frank meeting with Sir David John & Charles Jamieson (CEO) covering the barriers to reaching a solution
13 Mar 02Public announcement of detailed discussions with two major holders on a resolution to the problem
16 Sep 02Corporate restructuring agreed in principle with two major shareholders
9 Jul 03Court approval for reconstruction scheme of arrangement (effective 15/7/03)
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Important InformationThis communication is directed only at Market Counterparties or Intermediate Customers, as defined in the Glossary of the Financial Services and Markets Act 2000. Any investment or investment activity to which this communication relates is only available to and will only be engaged in with such persons and any other persons who receive this communication should not rely on or act upon this communication.
This communication is issued and approved for the purposes of section 21 of the Financial Services and Markets Act 2000 by Hermes Investment Management Limited (“HIML”). HIML has its registered office at Lloyds Chambers, 1 Portsoken Street, London E1 8HZ.
Hermes Pensions Management Limited is the parent company of a number of companies falling within the Hermes Group. The main operating companies within the Hermes Group are Hermes Investment Management Limited (“HIML”), Hermes Administration Services Limited (“HASL”), Hermes Property Asset Management Limited (“HPAML”), Hermes Focus Asset Management Limited (“HFAM”), Hermes Focus Asset Management Europe Limited (“HFAME”), Hermes UOB Capital Asset Management Limited (“HUCM”), Hermes Private Equity Limited (“HPEL”) and Hermes Assured Limited (“HAL”). All of the above named companies (with the exception of Hermes Property Asset Management Limited) are separately authorised and regulated by the Financial Services Authority.
The Hermes Property Unit Trust (“HPUT”) is constituted by an amended and restated trust deed between the Committee of Management and the Trustee both of which are authorised and regulated by the Financial Services Authority. The Committee of Management appoints the trust manager (HIML) and the property managers (Hermes Property Asset Management Limited) and has overall responsibility for the trust.
Please note that the Financial Services Authority does not generally regulate any activities referred to in this document which are not regulated activities under the Regulated Activities Order 2000.
Hermes Absolute Return Fund (Guernsey) Limited is authorised by the Guernsey Financial Services Commission and is listed on the Irish Stock Exchange.
This document has no regard to the specific investment objectives, financial situation or particular needs of any specific recipient. This document is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Prospective investors must rely on their own examination of the legal, taxation, financial and other consequences of an investment in the funds, including the merits of investing and the risks involved. Prospective investors should not treat the contents of this document as advice relating to legal, taxation or investment matters. Before entering into an agreement in respect of an investment referred to in this document, you should consult your own professional and/or investment advisers as to its suitability for you and should understand that statements regarding future prospects may not be realised. No action should be taken or omitted to be taken in reliance upon information in this document. Figures, unless otherwise indicated, are sourced from Hermes.
The opportunities described in this document have unique risks that may make them unsuitable for certain investors and past performance may not be indicative of future results. Also, certain returns shown in this document are compared against returns for the relevant benchmark index during similar periods. It is important to note that the underlying volatility and risk of the funds’ portfolios and that of their benchmark indices vary materially. Property is an illiquid investment and may result in deferment of redemption of units. The value of the property is a matter of a valuer's opinion rather than fact.
This document should be read in conjunction with the fund listing particulars when available which will exclusively form the basis of any application. A comprehensive list of risk factors appears in the fund listing particulars and an investment should not be contemplated until the risks of investment have been considered fully.
Investors may not get back the full amount originally invested. The value of overseas investments will be influenced by the rate of exchange. The value and risks of underlying investment may be difficult to verify independently.
The provision of the information does not constitute an offer to purchase securities to any person in the United States or to any U.S. Person as such term is defined under the Securities Act of 1993.
Any person wishing to subscribe for any interest should satisfy himself as to the observance of the laws of any relevant territory, including the obtaining of any requisite governmental or other consent and the observing of any other formalities.
This document may include a list of Hermes Pensions Management Limited’s clients. Please note that inclusion on this list should not be construed as an endorsement of Hermes Pensions Management Limited’s services. Should you wish to contact a client for reference purposes, please let Hermes know in advance.