Q2 2014 Stewardship and Managing Equity Interests for Our Clients
Old Mutual Global Investors manages money on behalf of its clients with the aim of generating returns to meet their financial aspirations. As part of that process, we regard using our powers as shareholders, particularly the ability to engage with companies on a range of issues, as a key tool for relevant equity funds. To that end, we consider it appropriate to report on some of the activities we have undertaken as stewards of our clients’ interests, as well as for the purposes of complying with the UK Stewardship Code 2012.
Our reports will generally remove identification of the companies with which we are engaging. Our reason for anonymity is that, in our experience, undertaking discussions which may occasionally be sensitive or delicate in the glare of publicity is damaging. Publicity can cause a defensive reaction and lead to a board hardening its position so as not to appear to lose face. We would prefer to conduct a sensible dialogue with companies where, in the event of a change of policy, this can be adopted and not seen as a management climb down.
As set out in our voting policy document (http://www.omglobalinvestors.com/corporate/about-omgi/governance/) we control a wide range of equity interests. These range from short-term holdings, in which case it is not appropriate to vote, to derivatives (which cannot be voted on) to funds where the focus is on trading. Where our stewardship can be most effective, and where the bulk of our work will occur, is in long-only funds where the emphasis is on understanding and building a long-term investment and relationship with the company.
A sample of our activity for the second quarter of 2014 is set out below.
Competition, Health and Safety
We met a company as part of the regular one-to-ones following year-end results. The company had warned on profits earlier in the year on competition for a product line, particularly the threat of over-supply in the market and irrational competition. Discussions at the time of the warning and at our recent meeting covered this issue, testing the company’s apparent product superiority in the market and the extent of continuing profitability. We support the company’s current plans and are satisfied that it will take rational decisions regarding the product if conditions deteriorate significantly.
We also discussed the company’s accident rate with the CEO. A positive improvement, disclosed in the results, was undermined by fatalities. We were reassured that the company is reviewing processes and procedures and will be using external advice. We believe the company’s board recognises the seriousness of the issue regarding safety. The company is also aware that it is an issue that will be closely monitored by shareholders and other interested stakeholders. We confirmed with the company that the remuneration committee of the board reflected the events of the year in pay awards for senior executives.
In the light of discussions with the company, a decision was made to support the board on all resolutions at the AGM.
IT security In the UK, GCHQ has, in recent years, been drawing the attention of companies to the risk of computer hacking and subsequent theft of intellectual property from outside the UK. This company, as is the case with many others has operations in countries from which, it appears, a good deal of IT attacks originate. The company is well aware of the risks and keeps systems in the more ‘at-risk’ areas separated from the rest of the company’s network. The board receives reports on threats and executives at board level received regular reports on the attacks on the company’s networks. This is an area, as with many others, where we can only scratch the surface: only a detailed examination of a company’s IT security would fully suffice but that it not a realistic or viable option. However, confirmation that the board is aware of the risks, that the company considers it is part of the risk framework, and that cyber-attacks are reported to members of the board provides some degree of assurance.
Aligning pay, performance, personnel
In addition to discussing the on-going implementation of the company’s strategy with the company’s CEO and CFO, we:
- discussed the company’s pay outcomes for the senior executives for the recent financial year and the on-going pay structure with the chair of the board remuneration committee;
- met the chair of the company to discuss the company’s performance and governance. The meeting followed several years of continuing engagement with the current and former chairs on strategy, personnel and performance.
We met the chair of a company regarding the business and the role of the board. Regarding the business and the executive team, we are pleased to remain supportive. The company has a sound strategy with good implementation by a quality management team.
Uncertainty and review
Discussions with a company were held on the sustainability of the company's strategy and implementation of that strategy in a changing market. We also discussed the matter with other shareholders. Whilst the outcome is uncertain, the company has presented a reasonably strong case that it is following the right course of action. Questions also remain over execution, but the case for changing strategy again is currently on hold.
Banks, bonuses etc - Barclays
The company’s performance on addressing leverage has been positive over the year. However, work remains to do on returns, costs, capital and ring-fencing. The company is, we feel, justified in being given time for the transformation plan to take effect, including the issue of investment bank bonuses. We, like many others, had noticed the apparently high level of bonuses reported in the company's year-end results. The level of the bonus pool reflected, to a degree, the regulatory-mandated deferral of bonuses from previous years. The company had made efforts to lower rewards to gauge the impact on the business. Further, there is a lag between cutting staff numbers within Barclays and the benefit being seen in costs. While the company is moving in the right direction, the time lag between making changes and an impact on results will be to the consternation of critics of the banking industry.
The bonus issue at Barclays remains an area of concern to the general public but the bank is addressing the problem by exiting areas of the investment bank that do not generate good returns, or which do not fit with Barclays' new culture.
Discussions also covered capital requirements, the relationship of Barclays with regulators and politicians, mortgages and the structure of the group.
A company had recently experienced disappointing trading during a key period of the year. One area where the company was weak was in addressing and adapting to on-line trading.
Having communicated with the board executive directors and the chair, we had the opportunity to meet below-board executives responsible for operational areas of the business, including on-line. We were able to explore the plans that the executives are implementing, as well as the understanding of the risks faced by, and opportunities available to, the company (but without receiving any share price-sensitive information). This allowed us to further understand the company’s strategy and, importantly, the steps the company is taking to implement that strategy. The discussions put the company’s approach into context and allowed us to better appreciate the company’s objectives. Whilst the company has yet to reach an optimal position, we can be supportive of the steps being taken.
Working with other shareholders
We spoke to another fund management firm regarding the CEO of a company. The other shareholder had pressed us in the past to support a change of CEO. We did not consider it would be appropriate to change CEO at that point and believed the CEO needed time to effect changes the company required. The other shareholder agreed that, with several big milestones in the company’s development approaching and given some signs of an improvement, they were not actively pressing for the CEO to be removed. We will discuss the issue again later this year.
This contact provides an example of the day-to-day contact which has been occurring between some shareholders for some years. The UK Stewardship Code has, since 2010, further encouraged such discussions.
Pay to stay?
We were consulted by the chair of the remuneration committee of the board of a small company. The company’s CEO has performed well and the company is aware that the CEO is at risk of being head-hunted by rival firms. In order to address this, the company is seeking shareholder approval to make changes, in order to increase the pay of the CEO.
We believe that in the short term, the loss of the CEO would have a negative impact on the share price. Longer term, recruitment of a new CEO can be a risk in that the new CEO may not be as effective, or may cause some volatility in performance. Clearly, boards should work to avoid these effects but there remains some risk in any replacement for a capable chief executive.
The company proposed to increase the salary (a fixed cost) of the CEO up to a barely, in our view, competitive level. Rightly, it was in the area of performance-related pay that the company was making the material improvement. As a result, the CEO will only receive a material improvement in rewards if the company performs well. We tested and discussed the performance alignment of the new package with the company and agreed we could support the proposals.
It is positive to report that the chair of the remuneration committee has been diligent in defining new pay arrangements which are generally at a modest level and include setting robust performance targets and we are grateful for the approach the company has taken. Whether it is enough, however, remains to be seen. Unusually for shareholders in the current environment, we queried whether the level of potential reward was sufficient to ensure the CEO would stay. Any company needing a new CEO or head of division wants to recruit talented individuals who have a proven track record: this demand unavoidably plays a part in driving the upward ratcheting of executive pay and whilst that is not a popular line politically, it is simply supply (executives with a proven track record of success at listed companies – a limited supply) and demand (a company under pressure to recruit a successful leader with a track record of success – high demand).
We met the chair of a company in the finance sector to discuss the business and strategy (including limits on the size of the potential market and the availability of very good, highly competent managers in the financial services industry); acquisitions (the chair is well aware of the data demonstrating generally poor performance following acquisitions); the threat and opportunities posed by government policy and regulation in the area; executive pay (consistent with many other listed companies, salary levels did not increase by any more than staff in the firm and it was also noted that given the size of the company, executive pay levels are low); and, succession planning. We remain supportive of the company.
There are occasions where companies at which directors or senior executives served may subsequently face difficulties. It is prudent for shareholders to see what, if any, impact that may have on the current positions of the individuals concerned. One such meeting with a director occurred during the quarter. In this case, we were pleased, and relieved, that we were able to continue to support the director.
The chair of a company attended a meeting to discuss, amongst other things, progress in the company’s development plans. In one sector of its business, the company’s activity was in line with their plans. They had tested the systems and rolled them out for use, including during peak demand. The chair regretted there had been some delay in the past but was very confident the problems faced two years ago were overcome.
The company’s sector is subject to some government oversight and political attention. The chair noted the industry is becoming more adept at working together to communicate to the government more effectively how the industry works, and the benefits it can bring, and is hopeful the government is more accepting of that view.
Other issues discussed included cost, the size of the dividend relative to the profits the company might generate and potential for consolidation in the sector.
Old Mutual Global Investors has not, to date, regularly voted equity share interests at company Annual General Meetings and other meetings. That is changing. We are preparing a voting policy, we will be implementing proxy voting across relevant funds we manage internally over the coming months and we will also revise our statement of compliance with the UK Stewardship Code to reflect our more active stance in this area. Copies of the voting policy, the Statement on Stewardship and subsequent reports on voting activity will appear on our website in the coming months: http://www.omglobalinvestors.com/corporate/about-omgi/governance/