There is an article in the AFR today about the AMP announcing that it will take a less activist role in corporate governance. In the article by Angus Grigg, the public affairs director of AMP Jane Anderson is quoted as saying “We find it more effective to work privately and constructively in the best interests of our clients” in regard to criticising under-performing firms. AMP had previously been activist in corporate governance by publically announcing its displeasure with poorly run companies or conflicts of interest. Grigg’s article relates AMP’s role in forcing Solomon Lew to step down from the Chair of Myers after the Yannon Affair in 1995.
It is not surprising that investment management firms like AMP do not want to take on big corporations. How can they win by doing that? If they annoy a big corporation then their equity analysts and portfolio managers will be prevented from speaking to the executives of the firm and will therefore be cut off from a flow of information about what is happening in the firm. Much better to just keep quiet and just sell the shares if you don’t like the firm.
But the problem is deeper than that. Let’s take an example. Imagine that a portfolio manager working for a big investment management firm, not AMP, but a firm like AMP, has the ASX200 as her benchmark. That means that the performance of the portfolio that she manages will be measured against the return on the ASX200 index at the end of the year. Her bonus and career prospects will depend on how much she out-performs or under-performs the index by. Moreover, her employer, the investment management firm, will gain if she out-performs the index because it will cause new money to flow into the portfolio she manages and they will get the increases management fees.
Lets say that Woolworths is 3 percent of the index by value. Imagine that the portfolio manager has 6% of her portfolio in Woolworths. Then she is 100% over weight in Woolworths (6%/3% – 1). If Woolworths outperforms the index then her portfolio will outperform ASX200, so she is really hoping for a big return on Woolworths. Now imagine her holding of Woolworths is 3% of her portfolio — the same as the index. In that case she is indifferent as to whether Woolworths goes up or down. Finally, imagine that her holding of Woolworths is only 1% of her portfolio. Then what ? — yes, even though her portfolio is long Woolworths and it will benefit her investors if Woolworths goes up, it is in her private interest if Woolworths goes down.
There is obviously a major conflict of interest here between the portfolio manager and her investors. She is concerned with the relative performance of the portfolio and her investors are concerned with the total return on the portfolio. They always want Woolworths to go up if it is in the portfolio, but she wants Woolworths to go down if she is underweight Woolworths relative to the index. Nothing new here, of course, this is a very well understood principal-agent problem in delegated portfolio management.
This conflict means that around the world the investment managers who are most active in taking on poor performing corporate management teams are the public pension funds, because they are concerned with total return (absolute return) rather than relative return. The most famous of these is Calpers (the Californian Public Employee Retirement Scheme). Calpers invests over $300 billion to fund the pensions of public employees in California. The higher the return on the assets of Calpers the lower the amount of cash that the cash strapped Californian State Government will have to kick in for State employee pensions.
Because Calpers only cares about total return they are never secretly hoping that the stock prices of some firms go down. Calpers is aggressive in publically denouncing poor performing firms. It makes a list of the 10 worst performing large firms in America each year. They are activist in corporate governance, whereas investment management firms like Fidelity, American Century, Blackrock, etc. hardly ever publically criticise the management of US firms. They don’t have the incentives to do so.
Australia has been different from the US in this regard. Australian investment management firms like AMP actually have been quite vocal against poor governance in the past. But that seems to be coming to an end, which is a pity.