By Starovic, Danka
Financial Management (UK)
Most discussions about the state of UK corporate governance seem to be based on the assumption that investors are a homogeneous group, in much the same way that all listed companies are seen to have common attributes that can be discussed collectively. At best, investors are classified as either retail or institutional, the latter being conventional fund managers with clear terms of engagement and voting policies. A statement of principles by the Institutional Shareholders' Committee epitomises the idea of stewardship to which they would subscribe.
But the truth is that the investment world is far more complicated than that. Some investors are more active than others--many institutional shareholders don't engage with companies at all. Tracker funds, for example, follow the performance of indexes passively, whereas banks' proprietary desks try to exploit short-term trading opportunities. Similarly, hedge funds use a range of strategies, many of which are poles apart from those of conventional fund management. Yet they are all viewed as shareholders in governance discourse and in key pieces of regulation.
This homogenisation of shareholders may be a useful way of generalising, but it can obscure some of the complexity that listed companies must deal with in their quest to create value. It also assumes that all intermediate players in the financial reporting "supply chain"--analysts, for example--work on the basis that all investors' needs are the same.
The real difference may no longer be between retail and institutional investors, but between short- and long-term ones. The rise in short-term equity ownership, inherent in many of the investment strategies mentioned above, has drawn concern from many quarters. As far back as 1990, the Economist observed that there were few real owners left and that most people who traded in shares were "punters, not proprietors".
The background to the perceived rise of short-termism is complex. For one thing, time horizons in conventional fund management have shortened. The average tenure of a fund manager with a particular portfolio is under three years. It is also inherent in the way that fund managers are rewarded: if their performance is judged over the short term, it wouldn't be unreasonable to assume that their investment decisions may not always be in the long-term interests of the companies in which they invest. (You could also question whether the same thing is happening inside companies, where the average tenure of directors is also decreasing.) But there are other contributory factors--the most notable of which is the proliferation of hedge funds. They are a new breed of investors that has tended to be subsumed in the broader category of institutional shareholders.
Hedge funds have been in the news for all the wrong reasons recently: John Sunderland, the chairman of Cadbury Schweppes, made a scathing attack on them in a speech at the Investor Relations Society's annual conference. He criticised both hedge funds and equity analysts for short-termism and said that he viewed "shareholders as shareowners--someone whose interest in the success and prospects of the company lasts more than three weeks".
As an investment class, hedge funds are hard to define precisely--the differences between funds of this type can be more marked than the differences between traditional asset management funds and some hedge funds. But their one shared attribute is that they seek absolute rather than relative returns, which means that they try to outperform the market whatever the conditions.
The worldwide hedge fund industry has experienced an annual compound growth of about 13.5 per cent over the past decade, according to research by Radley & Associates. Globally, the total invested in them is 560bn [pounds sterling], which amounts to about 2 per cent of all funds under management. In Europe the number of hedge funds grew by 100 per cent between 2003 and 2004. …