When the UK government responds to the Kay Review of UK Equity Markets and Long-Term Decision Making later this autumn, it will focus the minds of asset managers everywhere on fundamental strategic issues. Kay’s central recommendation is that managers should take a longer-term investment approach, learning from the likes of legendary investor Warren Buffett.
Commissioned by the Department for Business, Innovation and Skills, the independent review recommends actions designed to benefit the wider economy, asset managers’ clients and the managers themselves. Published in July, it also recognises the importance of the asset manager’s role at the centre of the investment value chain.
Above all, the review implicitly advocates that asset managers should seek a better balance between their own interests and the interests of their clients and the economy as a whole. In the view of the review’s main author, Professor John Kay, a shift to long-term ‘buy-and-hold’ investing based on fundamental analysis and ongoing engagement with investee companies, rather than shorter-term trading styles like algorithmic trading, would help economic prosperity. In this way, Kay believes asset managers could help companies to achieve better results, with subsequent economic and social benefits.
While Kay’s analysis and recommendations relate only to the UK, asset managers across much of the world are under pressure to help improve the functioning of financial markets, and to improve investment performance. The review explicitly suggests that asset managers deal with the first of these points by improving engagement with the companies in which they invest, and aligning their interests more closely with investor clients. What’s more, it also suggests that by doing so managers could be seen to help lift the performance of companies and increase returns to investors.
The UK government’s response will determine to what extent this review proves to be an agent for change. At the very least, we expect the government to seek to implement a key Kay Review recommendation, which is that an investor forum should be established. The forum would be a collaborative body that would work to improve company performance. Leading shareholders in listed companies would work together, seeking to influence major decisions such as the selection of a CEO or a shift in strategy. Although there are technical hurdles to forming such a body, such as whether investors’ would be judged as acting in concert for the purposes of takeover rules, Kay believes these could be overcome.
But beyond the forum, quite how far the review will prove to be an agent of change remains to be seen. Even so, asset managers might wish to look into its recommendations, to see if any of them help to inform their own strategy reviews. Certainly, current investment product trends suggest a renewed focus on long-term investment approaches.
The review makes various recommendations about restoring trust between asset manager and investor. Above all, it urges that all relationships within the investment chain should be fiduciary rather than contractual. It suggests that both the EU and UK regulatory authorities should look into the matter, and that the UK Law Commission also does so.
What’s more, Kay has specific recommendations about asset manager remuneration. He advocates that asset managers should make sure that individual portfolio managers’ long-term performance incentives should be in the form of either direct or indirect interests in their funds (so aligning the portfolio manager’s interests directly with his specific clients’). Pay shouldn’t be related to the short-term performance of either the fund or the asset management firm.
Finally, the review says that asset managers should improve disclosure, including actual or estimated transaction costs, and performance fees. Further, asset managers should disclose all income from stock lending and give their investors rebates accordingly.
Taken together, these recommendations have the power to revolutionise the relationship that asset managers have with both their clients and the companies in which they invest. The recommendations address issues that asset managers have identified as key, and they might well find that adopting them helps to build trusting relationships.
By recommending that the UK asset management industry adopts a longer-term, activist approach, as well as improving disclosure, Kay makes a useful contribution to the strategic debate about how the industry should adapt to a more hostile financial environment. As such, both its high-level recommendations about how to create value for clients, and more detailed ones relating to reporting and transparency, will interest asset managers everywhere.
At a time when many asset managers are seeing profitability under pressure, these issues are all highly relevant. The Kay Review makes fairly high-level – but strategically fundamental – recommendations. Implementing such far-reaching change will require expertise in both change management and technical areas such as remuneration and reporting.
In the next few months, the UK government will decide whether to institute Kay’s investor forum. The forum is likely to be a valuable step forward, but we think the Kay Review’s contribution to the debate about asset managers’ future strategy will extend still further. Looking into the issues Kay raises, and assessing whether they merit action, can only help asset managers to prepare for the future.
Simon Wasserman, the author of this article, was part of the Kay Review team.