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The New Focus for Global Investors: Responsible Investment and Active Share Ownership 26 th September 2006. CIBC Centre for Corporate Governance and Risk Management. Colin Melvin Chief Executive, EOS.

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slide1

The New Focus for Global Investors: Responsible Investment and Active Share Ownership26th September 2006

CIBC Centre for Corporate Governance and Risk Management

Colin MelvinChief Executive, EOS

The Hermes Group operates through a variety of separate and distinct legal entities, including Hermes Investment Management, Hermes Focus Asset Management and Hermes Property Asset Management. Issued and approved by Hermes Investment Management Limited, authorised and regulated by the Financial Services Authority.

agenda
Agenda
  • Introduction
  • Best Practice in Responsible Investment
    • Institutional Shareholders’ Committee Statement
    • ICGN Statement of Principles on Institutional Shareholder Responsibilities
    • UN Principles for Responsible Investment
  • Responsible Investment in Action: Hermes Equity Ownership Service
  • Conclusion
introduction to hermes

Aligned with pension fund goals and objectives

Introduction to Hermes
  • Hermes is unique in the investment industry
  • Independent investment manager of c.£63bn*. 3rd largest Pension Fund Manager in UK**
  • Hermes is the ‘executive arm’ of the largest UK pension scheme, the British Telecom Pension Scheme
  • Heritage and ownership aligns Hermes with long-term orientated pension funds and other investors
  • Performance is the key - not asset/revenue growth driven

* As at 30th June 2006 Source: Hermes ** Source FTFM Survey 05/06/06

issues for trustees as equity investors
Issues for Trustees as equity investors

LEGISLATION/

REGULATION

FUNDING

DISCLOSURE

STEWARDSHIP

PERFORMANCE

MEMBER

AWARENESS

TIME

SINGLE ISSUE

ACTIVISTS

Stewardship is central to the Trustees’ role

stewardship value and engagement overview
Stewardship, Value and Engagement – Overview
  • Academic
  • LBS “Shareholder Activism in the UK - A Clinical Study” ** found value created through shareholder engagements
  • Gompers found a fund taking long positions in top decile Governance ranked companies and short positions on bottom decile would have outperformed the market by 8.5% p.a. throughout the 1990s ***
  • Deutsche Bank research shows a positive relationship between historic governance assessment and profitability (ROE) ****
  • Practical
  • Hermes Focus Funds outperformed since inception
  • CalPERS“Corporate Governance has been best alpha driver over last 5 years, 2000 – 2004” – Mark Anson, former CIO
  • Relational Investors LLC (US) outperformed by 6.3% per annum *

** London Business School (2006)

*** Gompers et al (2004)

**** Deutsche Bank (2004a), (2004b), (2003)

*see Appendix 1

Investment in stewardship adds value

best practice in responsible investment
Best Practice in Responsible Investment
  • Institutional Shareholders’ Committee Statement
  • ICGN Statement of Principles on Institutional Shareholder Responsibilities
  • UN Principles for Responsible Investment
institutional shareholders committee
Institutional Shareholders’ Committee
  • Best Practice
  • Statement of responsible investment policy
  • Monitor performance of and have dialogue with investee companies
  • Intervene where necessary
  • Escalate intervention on a case-by-case basis
  • Evaluate impact of responsible investment activity
icgn statement of principles
ICGN Statement of Principles
  • Best Practice
  • Institutional shareholders have internal and external responsibilities
  • Understanding the chain of ownership
  • Dealing with conflicts of interest
  • Responsibilities with respect to companies
  • The benefits of good internal governance
united nations pri objective
United Nations PRI objective
  • To develop and implement a set of global principles that facilitates the integration of environmental, social and governance (ESG) issues into mainstream investment practices
slide10

UNPRI Timeline

June/July 2004 – Klaus Toepfer of UNEP announces Principles for Responsible Investment process in London and UN Global Compact publishes first "Who Cares Wins" report.

April 2005 – First PRI Expert Group meeting in Paris.

June 2005 – UN Secretary-General Kofi Annan convenes first PRI Investor Group meeting at UN Headquarters, New York. 21 asset owners representing USD 1.7 Trillion. Subsequent meetings in Toronto, London, Boston.

April 27/ May 2 2006 – UN SG Annan rings bell and opens NYSE. PRI launched supported by 34 asset owners and 18 investment managers from nine countries representing more than USD 4 Trillion.

preamble
Preamble

“As institutional investors, we have a duty to act in the best long-term interests of our beneficiaries. In this fiduciary role, we believe that environmental, social, and corporate governance (ESG) issues can affect the performance of investment portfolios (to varying degrees across companies, sectors, regions, asset classes and through time). We also recognise that applying these Principles may better align investors with broader objectives of society. Therefore, where consistent with our fiduciary responsibilities, we commit to the following:”

the principles
The Principles
  • We will incorporate ESG issues into investment analysis and decision-making processes.
  • We will be active owners and incorporate ESG issues into our ownership policies and practices.
  • We will seek appropriate disclosure on ESG issues by the entities in which we invest.
  • We will promote acceptance and implementation of the Principles within the investment industry.
  • We will work together to enhance our effectiveness in implementing the Principles.
  • We will each report on our activities and progress towards implementing the Principles.
best practice and hermes equity ownership service
Best Practice and Hermes Equity Ownership Service
  • EOS
  • Hermes Principles
  • Vote all shares
  • Discussion with companies
  • Inclusion in core engagement programme where future intervention is required
  • Intervention on basis of formal proposal approvedby Responsible Ownership Committee
  • Regular meetings with directors
  • Work with other investors as appropriate
  • Public vote is last resort
  • Contact and actions recorded
  • Report progress to clients on regular and ad hoc basis
  • Best Practice
  • Statement of responsible investment policy
  • Monitor performance of and have dialogue with investee companies
  • Intervene where necessary
  • Escalate intervention on a case-by-case basis
  • Evaluate impact of responsible investment activity

EOS represents best practice for responsible investors

slide15

Engagement designed to enhance value

    • Proprietary screening system
    • Identifies potential for improvement in long term value
  • Intelligent voting
    • Vote all holdings in all markets (where possible)
    • Voting rational communicated to companies
    • Lever for change
  • Global coverage
    • Over 3,500 company meetings worldwide

Equity Ownership Service and Responsible Investment

Comprehensively address the needs of fund fiduciaries

slide16

Overview of EOS Activities

High

Intensityof involvement

Additional investment and engagement

on strategic issues etc

Focus Funds

Core engagement on strategic,

capital structure issues etc1

‘Tier 1’ engagement

  • Engagement on structural governance
  • Board structure
  • Pay
  • Succession planning
  • Social, ethical and environmental issues

‘Tier 2’ engagement

Contact driven by company consultation (on pay and other issues)

Voting activity, related discussions, letters and meetings

AllCompanies

Low

Government and regulatory engagement to ensure best possible backdrop for shareholder rights

slide17

Effective controls

    • Senior Hermes staff involvement (CEO, CIO)
  • Integrated approach

Fund Managers EOS Focus Funds

  • Rigorous monitoring and assessment
    • Financial evaluation
    • Engagement trail maintained on database

Equity Ownership Service – Process

A process designed to protect clients’ interests

slide18

Unrivalled resource

    • Over fifty people directly involved in governance and engagement
  • Comprehensive skills
    • Team includes a blend of skills from business strategy, consulting and investment banking. Allows engagement from position of knowledge and understanding
  • Governance expertise
    • Team includes some of the industry’s foremost governance experts
  • Ownership culture
    • We act on our clients’ behalf as an owner rather than a service-provider

Equity Ownership Service – People

slide19

What EOS Provides to Pension Fund Trustees

  • Insight
  • Hermes’ knowledge, expertise and advice
  • Reporting on activities and engagement
  • Feedback on market developments

Value

  • Activities designed to add economic value
  • Alignment with fiduciary duty
  • Engagement on financially material issues

EOS

Control

  • Retain ultimate voting control of your shares
  • Ability to initiate engagement on your issues
  • Input to direction and development of EOS

Access

  • Dedicated relationship manager
  • Regular formal and informal communication
  • Regular meetings
conclusion
Conclusion
  • Responsible investment is linked to corporate value
  • Conflicts of interest in the chain of ownership can impede accountability and the effectiveness of investors
  • Nevertheless, active share ownership represents a new focus for global and local investors
slide21

Shareholder Engagement Funds’ Performance

  • Stewardship Staff
  • Case Studies

Appendices

shareholder engagement funds

Appendix 1

Shareholder Engagement Funds
  • Launched February 2002
  • Investment universe: European stocks (European Economic Area ex-UK, plus Switzerland)
  • FUM(1) €1.5bn
  • Managed by Hermes Focus Asset Management Europe Ltd(2)

Nissay Hermes Stewardship Fund

European Focus Fund

  • Launched March 2005
  • Investment universe: 550 Japanese listed stocks
  • FUM(1)¥32bn
  • Managed by Nissay Asset Management Corporation
  • Advisors: Hermes Focus Asset Management(2)
  • Launched October 1998
  • Investment universe: FTSE 350
  • FUM(1) £977m
  • Managed by Hermes Focus Asset Management Ltd(2)
  • Relational investors LLC formed in 1996
  • Investment universe: US listed stocks with equity market capitalisations in excess of $1bn
  • FUM(1) $6.2bn
  • Managed by Relational Investors LLC
  • Launched March 2002
  • Investment universe: UK companies outside FTSE 350 (ex-Investment Trusts Index)
  • FUM(1) £143m
  • Managed by Hermes Focus Asset Management Ltd(2)

UK Focus Fund

Relational Investors LLC(3)

UK Small Companies Focus Fund

(1) Funds under management as at 30/6/06

(2) Relational Investors LLC (“RILLC”) is a Registered Investment Adviser in the USA. RILLC and Hermes Focus Asset Management Limited (“HFAM”) have a strategic marketing alliance.

HFAM does not have an ownership interest in RILLC and RILLC is fully independent of Hermes. This Fund has reached its capacity and is currently closed to new investments.

slide23

Focus Funds in PractiseThe Focus Funds’ performance has been positive, supporting our view that good ownership adds value

Performance (p.a.)

(3)

(2)

(1)

(launched 1 October 1998)

(launched 4 March 2002)

(launched 25 February 2002)

  • UK Focus Fund benchmark is FTSE All Share Total Return Index
  • European Focus Fund benchmark is FTSE World Series Europe (ex UK) Total Return Index
  • UK Small Companies Focus Fund benchmark is FTSE Small Cap (ex Investment Trusts) Total Return Index
  • All performance figures are annualised and relative performance is calculated on a geometric basis
slide24
Annualised Investment Performance Since Inception for other Hermes-related Shareholder Engagement Funds

Performance (p.a.)

(2)

(1)

(launched 1 July 1997)

(launched 16 March 2005)

  • Nissay Hermes Stewardship Fund benchmark is TOPIX
  • Relational Investors LLC benchmark is S&P 500
  • Relative performance is calculated on a geometric basis
eos provided by team with unparalleled experience and ability

Appendix 2

EOS Provided by Team with Unparalleled Experience and Ability

PLC Board experience:

John Leach 30+ years:ex-CEO Brent WalkerPaul Harrison 10 years:ex-CEO Hi-Tech Sports

David Pitt-Watson, Chairman

20+ years strategy: ex-co founder & MD, Braxton/Deloitte

Colin Melvin, Chief Executive

12 years governance experience; ex-Baillie Gifford, Standard Life

Paul Munn, Commercial Director

9 years PLC Board experience; ex-CEO Dawson International

Paul Lee 5 years governance and English law

Makoto Seta9 years professional experience; ex-Arthur Andersen

Karin Ri7 years professional experience; ex-Morgan Stanley; Nomura

Jennifer Walmsley5 years professional experience; former journalist

Ian Greenwood5 years professional experience; ex-NAPF; RREV

Elena Tedesco5 years governance; ex-Deminor

Hans Hirt4 years professional experience; English and German law

Hege Sjo

9 years professional experience; ex-CFO Norwegian Börs

Bess Joffe4 years professional experience; lawyer; ex ISS Canada

Naheeda Rashid2 years governance; ex-Baillie Gifford; RBoS

E

O

S

Senior strategy consultancy experience:

Wouter Rosingh 20+ years: ex-Director, Booz Allen Hamilton

Leon Kamhi 15 years: ex-Braxton/Deloitte

Corporate finance experience:

Stephan Howaldt 16 years: ex-Warburgs, Siemens Corporate

Investment experience:

Mike Weston 14 years: ex-Merrill LynchMarco Ricci 14 years: ex-Deutsche

Phil Harris 14 years: ex-Credit Suisse

Nigel Davies 17 years: ex-West LB

Other experience:

Corinna Arnold 14 years corporate governance & institutional relations

Tim Bush 12 years accounting and public relations

Mark O’Connor 12 years investor relations & marketing

Additional support from:

Mark Anson CEO, Hermes

Tony Good ex- Norwich Union

Mike Bishop ex- Morley

Mike Connors ex Barclays & Fleming

slide26

Appendix 3

  • Hanson
  • BAE Systems
  • Premier Oil

Case Studies

slide27

Case study – Hanson

  • Engagement Issues
  • Encourage board change, particularly succession to the chair
  • Encourage focus on operational effectiveness, if need be by changing management
  • Ensure that buybacks are restarted to increase debt/equity ratio
  • Consider sale of non-core businesses in Asia-Pacific and continental Europe
  • Test management thinking regarding a possible sale
  • Background
  • Board in need of refreshment and renewal
  • Management appears overly focused on financials to the apparent detriment of operational efficiency
  • Capital structure inefficient with insufficient debt
  • Non-core businesses dragging down returns and distracting management
  • Unclear whether there is value-added from combining aggregates with building materials (particularly brick) businesses

Engagement addresses strategy

case study hanson cont d

0.52

Hanson

Hanson Relative to the FTSE Europe Construction & Building Index

0.50

0.48

0.46

0.44

0.42

0.40

0.38

0.36

0.34

0.32

Q3\'O4

Q1\'05

Q4\'04

Q2\'05

Q3\'05

10

3

6

7

8

5

2

4

1

9

Case study – Hanson (cont’d)

Chart dates from 1 July 2004 to 4 August 2005

Source: DATASTREAM and Hermes Investment Management Ltd

Managing investments to create value

slide29

Case study – BAE Systems

  • Engagement Issues
  • Encourage board focus on rebuilding key relationships, without involving press headlines
  • Improve transparency and rebuild confidence following Nimrod and Astute failures
  • We expected that these aims would require a significant reshaping of the board
  • Ensure solved own problems before rushing into any substantial deal
  • Background
  • Public breakdown of key client relationship with MoD following problems with Astute and Nimrod contracts
  • Governance: Board dominated by executives, particularly with a long-serving executive chair and executive vice chair
  • Lack of transparency and so market confidence in management and the company
  • Concern that intended to merge into US rival at undervalue, before solved own problems

Engagement addresses board renewal

slide30

24 June 04

Meeting with Dick Olver to agree agenda

H2 03

Ongoing contact with Sir Peter to reinforce comments

24 April 03

Meeting with Sir Peter Mason, chair of nominations committee, on requirements for next chair

10 Feb 03

Ensured could speak for investors holding c15% of the shares

280

7 Mar 05

Announcement of acquisition of United Defense industries for £2.2bn

260

1 May 03

Facilitated meeting with Sir Peter for 10% holder

11 Feb 03

Phone conversation with Sir Robin Biggam, SID

240

6 Mar 03

Meeting with executive management

220

14 Feb 03

Follow-up letter which was shared with the board

200

180

1 July 04

Olver takes over as chairman

160

14 July 03

Meeting with Michael Hartnall, chair audit committee

24 Mar 04

Announcement of Dick Olver, former BP deputy CEO, as next chair of BAE

140

20 Feb 03

Significant board changes announced and follow-up meeting with Sir Robin

120

100

2003

2004

2005

Case study (cont.) – BAE Systems

PRICE REL. TO FTSE ALL SHARE - PRICE INDEX

PRICE

Source: DATASTREAM/Hermes

Managing investments to create value

slide31

Case study – Premier Oil

  • Engagement Issues
  • Find route to give company independence from dominant holders as intended strategy now abandoned; cut debt
  • Remove some, add new independent directors
  • Justify the risk taken by being present there, or exit the country
  • Exit mature assets, slim down and refocus on fleet-of-foot exploration and production activities
  • Improvement to come from addressing agenda issues above
  • Background
  • Capital structure: two dominant shareholders (each 25%) and overburdened with debt
  • Governance: Six of eight non-executives not independent
  • Risk management: largest UK investor in Myanmar (Burma)
  • Strategic: locked into mature assets, not lightweight explorer where could have competitive advantage
  • Long-term share price underperformance

Engagement addresses CSR and its value impact

slide32

50

45

40

26 Oct 00

First meeting of group of

fund managers and campaigning groups

19 Dec 01

Frank meeting with Sir David John & Charles Jamieson (CEO) covering the barriers to reaching a solution

9 Jul 03

Court approval for reconstruction scheme

of arrangement

(effective 15/7/03)

35

16 May 01 AGM

Public acceptance that two major holders weigh on share price

16 Sep 02

Corporate restructuring agreed in principle with two major shareholders

29 June 00

First face-to-face discussion with company

on risk management

30

25

20

13 Mar 02

Public announcement of detailed discussions with two major holders on a resolution to the problem

9 Jan 01

Constructive first meeting with chair, Sir David John

15

18 Oct 01 EGM

Agreement to slim down asset base

10

2000

2001

2002

2003

Case study (cont.) – Premier Oil

PRICE REL. TO FTSE ALL SHARE - PRICE INDEX

PRICE REL. TO FTSE OIL & GAS SECTOR

Source: DATASTREAM/Hermes

22/7/03

Managing investments to create value

slide33
Important InformationThis communication is directed only at Market Counterparties or Intermediate Customers, as defined in the Glossary of the Financial Services and Markets Act 2000. Any investment or investment activity to which this communication relates is only available to and will only be engaged in with such persons and any other persons who receive this communication should not rely on or act upon this communication.

This communication is issued and approved for the purposes of section 21 of the Financial Services and Markets Act 2000 by Hermes Investment Management Limited (“HIML”). HIML has its registered office at Lloyds Chambers, 1 Portsoken Street, London E1 8HZ.

Hermes Pensions Management Limited is the parent company of a number of companies falling within the Hermes Group. The main operating companies within the Hermes Group are Hermes Investment Management Limited (“HIML”), Hermes Administration Services Limited (“HASL”), Hermes Property Asset Management Limited (“HPAML”), Hermes Focus Asset Management Limited (“HFAM”), Hermes Focus Asset Management Europe Limited (“HFAME”), Hermes UOB Capital Asset Management Limited (“HUCM”), Hermes Private Equity Limited (“HPEL”) and Hermes Assured Limited (“HAL”). All of the above named companies (with the exception of Hermes Property Asset Management Limited) are separately authorised and regulated by the Financial Services Authority.

The Hermes Property Unit Trust (“HPUT”) is constituted by an amended and restated trust deed between the Committee of Management and the Trustee both of which are authorised and regulated by the Financial Services Authority. The Committee of Management appoints the trust manager (HIML) and the property managers (Hermes Property Asset Management Limited) and has overall responsibility for the trust.

Please note that the Financial Services Authority does not generally regulate any activities referred to in this document which are not regulated activities under the Regulated Activities Order 2000.

Hermes Absolute Return Fund (Guernsey) Limited is authorised by the Guernsey Financial Services Commission and is listed on the Irish Stock Exchange.

This document has no regard to the specific investment objectives, financial situation or particular needs of any specific recipient. This document is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Prospective investors must rely on their own examination of the legal, taxation, financial and other consequences of an investment in the funds, including the merits of investing and the risks involved. Prospective investors should not treat the contents of this document as advice relating to legal, taxation or investment matters. Before entering into an agreement in respect of an investment referred to in this document, you should consult your own professional and/or investment advisers as to its suitability for you and should understand that statements regarding future prospects may not be realised. No action should be taken or omitted to be taken in reliance upon information in this document. Figures, unless otherwise indicated, are sourced from Hermes.

The opportunities described in this document have unique risks that may make them unsuitable for certain investors and past performance may not be indicative of future results. Also, certain returns shown in this document are compared against returns for the relevant benchmark index during similar periods. It is important to note that the underlying volatility and risk of the funds’ portfolios and that of their benchmark indices vary materially. Property is an illiquid investment and may result in deferment of redemption of units. The value of the property is a matter of a valuer\'s opinion rather than fact.

This document should be read in conjunction with the fund listing particulars when available which will exclusively form the basis of any application. A comprehensive list of risk factors appears in the fund listing particulars and an investment should not be contemplated until the risks of investment have been considered fully.

Investors may not get back the full amount originally invested. The value of overseas investments will be influenced by the rate of exchange. The value and risks of underlying investment may be difficult to verify independently.

The provision of the information does not constitute an offer to purchase securities to any person in the United States or to any U.S. Person as such term is defined under the Securities Act of 1993.

Any person wishing to subscribe for any interest should satisfy himself as to the observance of the laws of any relevant territory, including the obtaining of any requisite governmental or other consent and the observing of any other formalities.

This document may include a list of Hermes Pensions Management Limited’s clients. Please note that inclusion on this list should not be construed as an endorsement of Hermes Pensions Management Limited’s services. Should you wish to contact a client for reference purposes, please let Hermes know in advance.

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