Business, Innovation and Skills CommitteeSupplementary written evidence submitted by Aviva plc

Financing Long-term Investment Research

A proposal to increase investor stewardship

Among the most significant capital market failures is the failure of investors to be long term in their investment analysis and then behave as responsible owners—or stewards—of listed companies.

This lack of long term stewardship has been identified as an economic problem by successive Government reviews [Cadbury (1991); Hampel (1998); Walker (2009); Kay (2011)]. It is also considered by many experts to have been a significant contributory factor to the financial crisis (Walker, 2009).

The specific market failure is that responsible ownership is a non-excludable public good, ie the benefits of engagement are enjoyed by all owners regardless of whether they behave as responsible long term owners. Consequently, the vast majority of profit maximising commercial fund management institutions free ride and either do not do stewardship at all, or invest only token resources in this work.

Stewardship is under-funded and arguably profoundly so. We estimate that the average budget of a FTSE 100 company for compliance with the Corporate Governance Code is c. £5million per annum in comparison with the average budget of the top 100 fund managers on Stewardship, which is in the order of £120k.

This is not a discussion of equals. How can investors support leading companies that conduct thorough stewardship, or—perhaps more importantly—challenge the laggards, when the resources that they invest in this area are practically insignificant?

As noted, there has been considerable work in this area, yet Professor Kay’s recent Review of Equity Markets and long-term decision making surprisingly does not consider how to significantly increase either the economic demand for, or the financial funding of stewardship. In general, it is assumed that fund managers will be responsible and accept their public interest role for them to conduct stewardship and voluntarily invest more in their stewardship work. This is misguided at best and economically naive at worst. Unfortunately, without demand from beneficiaries and a financial funding solution, the scale of investment stewardship will be piecemeal and disproportionately low. Investor stewardship makes financial sense for fund managers as it improves the long-term health of their funds but they are not currently equipped with the research that will allow them to pursue long-term investment strategies.

Fortunately, as Professor Kay recognises, there is no shortage of money in the system for financing the work of the various market intermediaries. Equity commissions are attached to every trade, which despite belonging to the asset manager’s client are spent by the asset manager. Most equity commissions are split into two parts: execution (for the physical cost of trading and executing the transaction) and non-execution (for all other services including investment research). The latter can be used to buy research from any type of provider and this global research spend amounts to $22 billion per year (Source: Frost Consulting, July 2012).

A few fund managers—including Aviva Investors—are directing this research commission towards brokers and independent research providers of long term investment research, voting advice and stewardship work. We are clear that such investment in stewardship adds value to investment decisions and is in the long term interests of our clients. However, this approach remains uncommon and those fund managers that do utilise this mechanism tend to spend only a few percentage points of their research commission in this way.

We believe that if the FCA were to take the following four steps, then it would significantly increase the scale of stewardship resources in the market and fundamentally transform the delivery of long term investment analysis and investor stewardship:

1. The FCA could clarify that long term investment research that is orientated towards good stewardship behaviour by investors can be paid for in this way.

2. The FCA could suggest as a guide that it is good practice for a material proportion of the commission research (say 10–25%) to be spent in this way.

3. The FCA could say that it is good practice for fund managers to be transparent to their clients that this was taking place.

4. The FCA could say that it is good practice for clients to be allowed to opt out of this, as long as they are clear to their beneficial owners what their rationale is for so doing.

This would have the following benefits:

The market for stewardship would be transformed with materially more resources flowing into this work.

Companies would benefit from engaged, informed and responsible owners raising any concerns at an early point without the need to use the press to highlight their issue.

The end owners of the assets and, therefore, the beneficiaries of the stewardship work , would be financing the stewardship on their assets through their trading commission.

The government would be creating an enabling environment for responsible capitalism at no cost to the exchequer and with no long term regulatory burden.

Steve Waygood
Chief Responsible Investment Officer
Aviva Investors
18 March 2013

Prepared 24th July 2013