Friday 31st October 2014                 Change text size:

The principles of responsible investment – a short series. Principle two – active ownership.



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The second principle states that signatories will “be active owners and incorporate ESG issues into our ownership policies and practices.”

In the beginning, owner-managers ran their own businesses using their own money. Then a group of persuasive entrepreneurs sold shares to people they knew. This allowed them to raise funds so they could invest in more capital. In turn, this meant that they could afford to grow their businesses faster than they could grow on their own.

Over time, the business-owner-investor relationship became more distant as owners delegated the running of their organisations to a managerial bureaucracy and allowed those managers to run their investments and businesses. Finally, they spread their risk over multiple ventures in multiple sectors across multiple territories through multiple money managers. This meant their ‘ownership’ of any one organisation was reduced to fraction of a decimal of a Percent, often held for a short fair weather period and with no interest in the actual function of the company.

For the time being the active owner was dead, apart from in small to medium sized enterprises and some very rare large ones. Business strategy and management was devolved to a managerial bureaucracy whose own tenure was often short-term and whose sole goal was to maximise profit by all means necessary, in the time they had.

This model seemed to serve society tolerably well as our own economy grew, shareholders earned dividends and saw the value of portfolios rise, households became more affluent and there was plenty of stuff to go round.

Then in 2007 the system failed catastrophically, as it had failed with remarkable regularity over the previous eighty years.

Prudent checks and balances in the system had been abandoned in the 1970s and 1980s. Capital had become hypermobile across industries and borders. Financial speculation became an end in itself, rather than a means of creating real investment in real businesses. In the pursuit of profit, any remaining responsibilities to the environment and societies from which these companies emerged were forgotten. Costs like environmental protection, expensive home-grown employees or the taxes that housed, educated or healed them had to be avoided.

There were to be no limits to growth. Institutional investors and the managerial bureaucracy conspired to game the system to their advantage. They sat on each other’s remuneration committees, owning stakes in each other as a cosy cartel. This allowed them to guarantee escalating rewards regardless of business or share performance. The owner or individual investor was side lined, alongside the home-grown employee and customer, as their stakes in the businesses became irrelevant against the scale of financial speculation. By 2010, for every £1 of real trade, £26 was speculated financially.

There are some who would argue that this failure of capitalism is systemic and inevitable.  To a certain extent they are right, markets are unregulated and if shareholders can or wish to, they can exert no influence over their holdings. If management bureaucracies are free to ignore shareholder votes, they will. However, those who see the failure of capitalism as a good thing tend not to live in the countries that been recent beneficiaries of free trade, or have a very weak grasp of history and the downsides of alternative systems.

But capitalism and the foundation of equity investment both need to return to their mercantile and innovator roots. Owners of companies, the majority of whom are institutional investors, need to exert greater influence over, and engage with, their holdings’ managerial bureaucracies. They should demand higher performance, environmental, social and governance standards. If for no other moral or ethical reason it will protect their investment in a resource scarce, polluted, less stable world.

As individual investors, we can demand that those funds we invest in exert this influence, or not invest in them. We have regularly argued that we live in an incredible time of limitless information and connectivity. If you are lucky enough to have a portfolio you have three votes in our economy compared to most people’s two – as a voter (every five years or so), as a consumer (every day) and as an investor (at least every March), whether directly or through a proxy.

Tomorrow we move onto disclosure.

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