Sunday, 17 March 2019

What business are asset managers in?

Another issue I am starting to look at in more detail is the overlap between stock-lending, shorting and other activity. I was recently pointed in the direction of some of BlackRock's literature on stock-lending and it fed my sense that at least parts of its business are not necessarily all about asset management as we might typically understand it.

Here are a couple of excerpts:



The first bit shows you how it works (in this case for Exchange Traded Funds). You deposit money with Blackrock in an ETF invested in a stock index. Blackrock lends some of the stock (for a fee, obvs) to an institution and uses the collateral provided in return to potentially get a return from a money market fund. Blackrock splits the income generated with you and offsets this against the management fee. In some cases the lending income you get is larger than the management fee.

What's Blackrock's cut of the lending income? About a quarter to a fifth according to the blurb:


(incidentally, Blackrock looks like it takes a bigger cut of lending income from European funds, but that's another story)

So if we assume that the 73.5% figure applies to the top 3 Russell 2000 ETFs in the list, then that suggests that the total lending income from these funds is 35bps, 27bps and 19bps respectively. That would make total lending income 40%+ higher than the management fee in the first two cases, and 21% lower in the third. If that 73.5% is correct then Blackrock's cut of the lending fee (26.5%) adds a reasonable chunk to their overall income.

iShares Russell 2000 Growth ETF - Management fee (24) + lending fee (9) = 35bps
iShares Russell 2000 ETF - Management fee (19) + lending fee (7) = 26bps
iShares Russell 2000 Value ETF - Management fee (24) + lending fee (6) = 30bps

There may even be a dribble more income for Blackrock as I assume that they would use their own money market fund to stick collateral in, so perhaps another management fee there?

If the actual level of stock-lending income in some of these cases is higher than value of managing the portfolio of assets, that suggests that there must be quite a lot of lending going on. Does it also suggest that the funds don't hold own the stock in the index they notionally track for prolonged periods? I don't know anything like enough to comment sensibly.

But what is quite obvious is that this looks like a nice business to be in. You take the clients' money to put in, say, a US smallcap ETF. You loan the stock out to someone who wants to borrow (for whatever reason) and take a decent cut from the income from renting assets bought with your clients' money. And you might even be able to make a few crumbs managing the collateral the lender gives you while the stock is out on loan.

Questions this raises for me are what is Blackrock really selling (and what are you really buying), and how does it see the business? It would be really interesting to see how much of the stock is out on loan at any time, because to me it looks a bit like in some cases Blackrock runs a stock-lending service facilitated by having an asset management offering. If the total income generated (though not Blackrock's cut) is higher from the former than the latter, how is it seen internally?

It's also important in the current context where asset management fees are in the spotlight. Based on the fees above, it looks like they are giving the asset management away for free for some ETFs - a very tempting offer. In reality they are actually earning more than the headline management fee, from two sources. And it only hangs together because the client provides the money to make it work and because lending is lucrative.

Some of this reminds me of the origins of asset management. Back in the 70s and even into the 80s, asset management was not a big deal in a lot of markets. Banks provided it as an add-on service alongside more profitable areas of work. Peter Stormonth Darling's book on the history of Mercury Asset Management is fascinating on the early history of that manager (which ultimately ended up as part of.... Blackrock). Warburgs were pretty much willing to give the business away to Flemings at the end of the 1970s, but couldn't. It was only when they realised that they could get away with charging a lot for the service that the industry really took off, and created what we see today.

Perhaps now that fees are (finally) under serious scrutiny we'll see more of this kind of activity as managers look to try to make money elsewhere to keep the fees they charge down. But as I say, it does raise some questions about what the business really is. And this is without even getting into the question of Blackrock's numerous short positions, and where the stock comes from for them.

Outsourcing hell - continued

If anyone were in anyone doubt that the outsourcing sector is in big trouble, Friday saw Interserve's precarious position finally resolved. The major shareholder - US hedge fund Coltrane Asset Management - voted against the proposed debt-for-equity swap, which in turn will lead to the company going into administration. Already a couple of other outsourcers are sniffing around to see of it's worth trying to pick off some of the better bits of the business.

Ultimately Coltrane and the board of Interserve played a game of chicken and in the end neither side blinked. As usual in these circumstances it is tempting to see the US hedge fund as the bogeyman. So it's important to remember that the leadership of Interserve (like Carillion before it) got the company into this mess, the hedge funds didn't create it. Nonetheless, when faced by pleas from management not to vote against the de-leveraging plan, with the knowledge that this would trigger administration and create huge uncertainty for the workforce, Coltrane's stance is not going to win many fans. 

The role of hedge funds in this one was interesting as Coltrane and Davidson Kempner were on opposite sides (the latter on the debt side) rather than, as you might expect, shorting. It's also notable that Coltrane had previously shorted Carillion and is currently shorting Mitie Group (interesting, given the latter's interest in bits of Interserve).


I guess they must think they can sort the wheat from the chaff in the outsourcing sector, but their experience with Interserve must have been pretty painful.

So first Carillion, now Interserve and Kier Group wobbles along after a rights issue flop and a new upward revision in its debt. To state the obvious, there's a sectoral problem and it looks like consolidation is likely. That in turn might start to sharpen the questions about what we've actually achieved with all this outsourcing. If we end up with an oligopoly of outsourcers it will become a bigger political problem. But we aren't there yet.

I haven't seen much coverage of what's going from the corp gov / ESG world (would be interested if anyone has seen some). There is a sectoral problem, with jobs and service provision potentially at risk. Maybe it will get more attention from here on, it surely deserves to.

Also, what does stewardship mean in this context? As far as I can see Coltrane doesn't make or need to make any kind of Stewardship Code statement. On the other side of the Interserve story, Davidson Kempner uses a version of the same generic blah as dozens of other hedge funds that neither the FCA nor FRC seem to have shown any interest in challenging. These are firms that can have a huge influence on major employers, but don't need to say anything about what they do and why. I does kind of make you wonder what the point is. The Stewardship Code sometimes seems to be more about reporting / promotion than what's under the bonnet.

Sunday, 10 March 2019

Interserve & hedge funds

The ongoing battle at Interserve is grimly fascinating. The company's biggest shareholder is hedge fund Coltrane Asset Management which is trying to scupper the board's plans for a debt-for-equity swap. This would (obviously) be bad news for existing shareholders, but it looks like the company would go into administration if its plan does not proceed as planned.

There is come great coverage in the Sunday Times today, including an interview with the chief exec Debbie White. She argues: "People seem to have lost sight of 68,000 people's livelihoods [and] thousands of clients and suppliers for whom Interserve is an integral part of their lives."

I'm interested in Coltrane's role as a shareholder, as I've primarily come across them on the short side. They had a smallish short position in Carillion before it failed, and currently has a fairly sizeable short in Mitie Group. Here are its current shorts above 0.5%:


Funnily enough, there's another hedge fund I've come across several times - Davidson Kempner - on the debt side of Interserve.

By the by, Davidson Kempner currently has no shorts listed in the FCA list. In fact it hasn't had any in the list since April 2018 when it wound down its long/short merger arbitrage trade around the takeover of GKN by Melrose. Perhaps it's not shorting anymore, or perhaps it has some sitting at 0.49% or below. The more I dig into this stuff the more I wonder why the FCA sets the bar so high for disclosure.

Saturday, 9 March 2019

Changing of the guard in corporate governance

I have been blogging a lot recently about employee representation on boards. This is partly because I'm an advocate of it, partly because no-one else seems to be tracking the issue properly and partly because I think the issue is part of a significant shift that deserves more scrutiny. So I thought I'd write something a bit longer than usual looking at a few interlocking themes.

1. Employee representation at board level, state of play 

Just a quick recap, there are now four UK-listed companies with employees in their board structures:

FirstGroup
Mears Group
Sports Direct
TUI

The last one is unusual as it's incorporated in Germany but listed in the UK (and in the FTSE100). Because of its size it is required to have the co-determination model of governance, so it has a supervisory board with half employee reps, including union officials. None of the TUI employee reps are from the UK as far as I can see.

Of the the other three, two are female and one male. For completeness there is also a female UK employee director on France-listed ATOS. So I think there are (at least) four UK employee directors, three of them female. There will be more. We also know that Capita is recruiting two employee directors (which will make it the first UK PLC to have multiple reps), and there may be others going down this route that we don't know about yet.

As for companies choosing alternative models, here are those that have made public that they are designating an existing NED to represent employees:

Diageo
Hays
Legal and General
McKay Securities
Ted Baker

But there will be plenty more choosing this option. For now...

2. Opposition to and biases about employee representation 

It is worth restating that employee representation at board level has been opposed by a lot of powerful players in mainstream corp gov. This has varied from outright opposition to putting forward much weaker alternatives (like designated NEDs). I think that publicly-articulated views have been toned a bit over the past couple of years, but here's a reminder of some asset managers' positions. I'm also struck by the tone of this comment from the ICGN:
In Provision 3, we believe it does make sense for boards to understand views from the workforce, and it is important that flexibility is granted about which approach would work best for individual companies. The workforce is a critical stakeholder for long-term company success, but companies and workers must remember that the workforce of one of a number of important stakeholders—and the workforce should not become the board’s proxy for all stakeholders. 
And here is another mainstream corp gov view from Eumedion:
Although we understand these proposals [for workforce engagement] in the UK context, we believe that these proposals can have unintended consequences as they can increase tensions between stakeholders themselves and between the board and the various groups of stakeholders. Those tensions will typically appear in stretching situations, such as in the situation of an unsolicited takeover proposal or in the situation of pressure from specific short-term oriented shareholders to change the company’s strategy and policy. 
It is worth anyone interested in corporate governance probing these arguments, as there are some meaty issues (and assumptions) buried within them. I am frequently shocked by the patronising tone that many people adopt when discussing these questions, revealing a low opinion of employees. The implications are often that employees lack the ability to contribute anything constructive, or to think long-term about the company they work for, or to pick representatives who will be effective.

It reminds me of a speech I saw once by a trustee of (I think) WH Smith pension fund. He had previously been an exec at the company (possibly FD?) but had ended up becoming a member trustee for some reason. He said he found it eye-opening because he realised when he was wearing the "company" hat he simply could not see pensions issues independently, even though he thought he could. His views were shot through with the biases that came from his position. He didn't realise this until his position changed.

My point is simply that we are all biased, and we all have views that are shaped by the interests that derive from our current position. I am obviously biased, for example, because of my experience in the labour movement (see note at the end for more info about how this can screw up the way I look at things!). My argument is that in this particular discussion mainstream corp gov organisations often seem to reflect quite deep biases. Perhaps, like the trustee, they can't even see them from their current position.

3. The 'centre' has shifted to the Left, even if corp gov hasn't noticed 

Again, I have blogged about this before, but it is striking that in public policy the idea of employee representation at board level is totally mainstream. All the major political parties have committed to it, and it is the Conservatives who have made the first attempt to introduce it. We can also see from polling - in the UK and US - that the idea is popular with the public, including quite a few Right-leaning voters.

The idea is attracting more attention because of the increasingly widely held view that workers in countries like the UK and US have had a pretty rough time of it in recent history and that capitalism has to change a bit if we're to prevent political problems. We're also starting to see quite frequent pieces questioning whether shareholder primacy is part of the problem. A theme I'm trying to work on is what comes next - I think (at least) it will involve reformed directors' duties, employee representation and greater pre-distribution through ownership, profit-sharing etc. I've also argued that shareholder primacy in utilities is under threat.

I think it's entirely fair to say that these views have come almost exclusively from the Left up until the last five years or so. But now they are pretty much the centre ground in public policy.

Enter Chuka Umunna, of the newly-formed Independent Group (TIG) of MPs, who has published a new pamphlet on what 'progressives' (bleurgh!!! hate that term) believe. I'll just pull out a few relevant bits:
What would this “British model” look like? It could take as its foundation northern European elements: employee ownership trusts; workers on boards and public-spirited non-executive directors, moving towards a form of co-determination as a way of decision-making in the workplace; trade unions; incentives for innovation within firms; long-term financing; and a National Investment Bank with a network of regional banks driving Britain’s public investment rate to the G7 average of 3.5%... The defining characteristics of this hybrid model would be: collaborative workplaces and competitive practices in innovative firms that pay a decent wage, share profits with workers, and give security to those who work within them.
.....
For example, the “British model” could create new tax incentives and legal certainty for mutuals and a vast roll-out of employee ownership because the evidence shows this would encourage long-term ownership and diversify ownership of capital. It would forgo the automatic assumption that nationalisation improves performance in favour of taking a “foundation” share in privatised utilities to force them to serve public good. It would incentivise widespread membership of collaborative unions and employee representatives on remuneration committees.
.....
Too many of the rewards of these new technologies accrue to a relatively small number of individuals, exacerbating inequalities. New ownership structures must be developed to ensure greater distribution of the benefits both to workers and wider society. Employee ownership trusts can be used to spread the rewards in such companies beyond the founders to the workers at large. 
.....
An incoming progressive government could legislate to force companies providing key public services to write the provision of public benefit into their constitution, taking precedence over profit-making. It can then insist on taking a "foundation share" in each company as a condition of its operating licence. This share can be used to install non-executive directors tasked with seeing that the company delivers its newly enshrined public purpose. This would be a smart use of government power for the common good – with shareholders retaining their shares, though now constrained by the primacy of public benefit over shareholder return.
This stuff is well to the Left of New Labour, and even significantly to the Left of Labour's Miliband era shadow business secretary... if anyone remembers him? But TIG is positioning itself as very much in the centre (the pamphlet is published by Progressive Centre). And I think views of this type is pretty much where the centre is going to be in the future.

Mainstream corp gov is simply not here yet, and as such is more likely to be affected by change than to shape it. Look forward another decade and I would not be surprised to see that employee directors are common on UK company boards, that employee ownership and/or profit-sharing has become more widespread. I would like to hope that there is some kind of push to reinvigorate unions too, but I am less confident on that front.

What I don't think will happen is that most UK companies designate an existing NED to engage with their workforce and it will end there. I don't think that a future government will observe companies avoiding having proper representation and think "this is fine, job done".

-----------------------------

Mea Culpa - as an important aside, I have to remember not to blog when I've got strong emotions about a subject! When TIG split off I thought I shouldn't blog about it as I have too much emotionally invested in the state of the Labour Party. I could see a lot of people predicting how TIG would position themselves - partly out of anger, partly trying to bomb their planes before they take off - and could see it was pointless. But because my emotions got the better of me I felt compelled to write something. And because I want to see a certain outcome I projected this. Bad mistake, made worse by the fact that I knew I was making it.

Wednesday, 6 March 2019

Wolfgang Streeck snippets

A couple of excerpts from How Will Capitalism End that resonates with me. The first has obvious application to Brexit (though this was written before it) though it also describes how I feel sometimes looking at ESG land.
[T]he arenas of distributional conflict have become ever more remote from popular politics. The national labour markets of the 1970s, with the manifold opportunities they offered for corporatist political mobilisation and inter-class coalitions, or the politics of public spending in the 1980s, were not necessarily beyond the grasp or strategic reach of the 'man in the street'. Since then, the battlefields on which the contradictions of democratic capitalism are fought out have become ever more complex, making it exceedingly difficult for anyone outside the political and financial elites to recognize the underlying interests and identify their own. While this may generate apathy at mass level, and thereby make life easier for the elites, there is no relying on it, in a world in which blind compliance with financial investors is propounded as the only rational and responsible behaviour. To those who refuse to be talked out of other social rationalities and responsibilities, such a world may appear simply absurd - at which point the only rational and responsible conduct would be to throw as many wrenches as possible into the works of haute finance.
The second is timely given a recent outbreak of bullshit about "non-ideological" and "evidenced-based policy.
Standard economic theory treats social structure and distribution of interests and power vested in it as exogenous, holding them constant and thereby making them both invisible and, for the purposes of economic 'science', naturally given. The only politics such a theory can envisage involves opportunistic or, at best, incompetent attempts to bend economic laws. Good economic policy is non-political by definition. The problem is that this view is not shared by the many for whom politics is a much-needed recourse against markets, whose unfettered operation interferes with what they happen to feel is right. Unless they are somehow persuaded to adopt neoclassical economics as a self-evident model of what social life is and should be, their political demands as democratically expressed will differ from the prescriptions of standard economic theory. The implication is that while an economy, if sufficiently conceptually disembedded, may be modelled as tending towards equilibrium, a political economy may not, unless it is devoid of democracy and run by a Platonic dictatorship of economist-kings. Capitalist politics... has done its best to lead us out of the desert of corrupt democratic opportunism into the promised land self-regulating markets. Up to now, however, democratic resistance continues, and with it the dislocations in our market economies to which it continuously gives rise. 

Monday, 4 March 2019

Ted Baker chief exec departure and workers on boards

I'm still tracking company announcements on if/how they are complying with the UK Corp Gov Code in respect of employee voice.

I've found two more choosing to designate an existing NED as employee representative. The first is the recruiter Hays, announcement here.

The second is more interesting - Ted Baker. The news that it has designated a NED to engage with the workforce is actually buried in the announcement that chief exec Ray Kelvin has resigned (having previously been on leave of absence). This follows allegations of inappropriate behaviour stretching back years.

I find this one very interesting as it strikes me that this shows exactly why employees on boards are a good idea. I have no doubt that if there were a couple on the board of Ted Baker then these allegations would have been properly discussed at board level a lot earlier than they eventually were.

Tuesday, 26 February 2019

Tech bros and 'win win'

Another couple of snippets from Winners Take All. This first quote is from a tech writer called Greg Ferenstein who interviewed lots of technology founders and tried to distil their ideas into a *cough* philosophy.
"The basis of old government is the notion of a zero-sum relationship between different classes - economic classes, between citizens and government, between the United States and other countries. If you assume that inherent conflict, you worry about disparities in wealth. You want labour unions to protect workers from corporations. You want a smaller government to get out of the way of business. If you don't make that assumption, and you believe that every institution needs to do well, and they all work with each other, you don't want unions or regulations or sovereignty or any of the other things that protect people from each other.
"Most politics and most institutions are built on a zero-sum relationship between some people in the group. This ideology is unique - and the reason I call it Optimism is because of the belief that everyone can get along. Or everyone has, to be more specific, overlapping preferences."
I could not have articulated the "win-win" mindset better myself. If we're all on the same side all the time, why do we need unions or regulations?

Secondly here is a tweet from a Silicon Valley venture capitalist called Paul Graham that is quoted in the book:
"Any industry that still has unions has potential energy that could be released by start-ups"