With that in mind, it's worth thinking about some of the things from this highly unusual period that might endure. Waking up to the absence of noise, and walking around seeing very little traffic, has been a revelation in London. But I suspect that travel levels will creep back up, which is rather sad. And in any case, I'm going to stick to my knitting and cover a few things I know a little about.
Concentration
Concentration - both in ownership and within sectors - is something I think could be a lasting effect of the crisis. On ownership first, I think the big asset managers, and particularly the passive managers, will emerge stronger from this crisis.
I've been following asset management for over 20 years, and throughout that time I've heard the argument made that it's during a downturn that you really want active management, rather than just tracking the index down. It's never been borne out by events, and throughout the past couple of decades all that is happened is that assets have shifted from active to passive. I think this crisis will only add to that trend.
There's an interesting piece in the FT on this topic here which points out that the concentration of assets with a handful of investment groups had surged since the start of 2020. The largest 1% of investors now account for 63% of total industry assets.
There are couple of noteworthy comments in the article below:
Mr Miller said that concentration was also accelerating at fund level, with investors channelling more money into large, low-cost, predominantly passive funds. “We’ve seen investors buck the idea that active managers can outperform in a downturn,” he said.and
Mr Miller warned that the concentration of assets in the hands of fewer decision makers could increase baseline market volatility in future. He added: “It could also make the heads of the largest asset managers incredibly powerful influencers of the global economy as they can exert serious pressure on their portfolio companies.”I don't currently see anything that is likely to change this. We can see ongoing consolidation within the industry and the continuing active to passive shift. On one level this is fine. I don't have much faith in active management, and the sheer number of active funds on sale seems ridiculous.
However, the concentration of power in the hands of a small number of players is significant. Some people in my world must think this is a good thing, since the separation of ownership (let's leave this aside for now!) and control is supposed to be the flaw in the public company that corporate governance and stewardship seeks to mitigate. But it doesn't feel like a victory does it?
The fact that this concentration is being driven in large part by investors going passive raises other questions. For example, at what point does that fact that much of the money invested in the market is not making active buy/sell decisions start to distort it? I remember first hearing this argument in the late 1990s when the point seemed fanciful, but we are now at the point where more money is being managed passively than actively.
Also, if asset managers have a position in a company simply because it is in a given index why should their views on ESG issues be more desirable than those of the underlying beneficiaries? Part of the story of responsible investment in the early years was that it was going to democratise the finance sector, and let those whose money was fuelling it have a greater say. But in practice what is happening is that large passive managers are agglomerating that power for themselves. My personal view is that the fact that it's investment professionals who call the shots in part explains why RI has such a wealthy liberal feel to it. But that's for another day...
Industry concentration
The other side of the concentration question relates to market structure. There are a number of elements to this. First, it's inevitable that this crisis will kill businesses that were already weak, in turn they might be picked over by other firms which survive and might be able to pick up bargains in the current climate.
Second, there are certain sectors that seem likely to be particularly affected. I read a piece on The Nation (which I can't find now!) looking at the impact on shopping streets in the US. The argument was that smaller independents would lose out to larger chains. Certainly it seems a safe bet that Amazon emerges stronger at the end of this. But it will surely go beyond this. Airlines looked ripe for more consolidation in any case as a number had failed or looked like they were going to.
Third, competition policy seems likely to be relaxed, even if not explicitly. For example, the CMA in the UK recently issued guidance on its stance in response to Covid-19. It essentially said that its position was unchanged. However the CMA's existing position was that it would take into account the financial viability of the company potentially being acquired. If there was a risk of business failure it might allow a takeover. Well, in the current environment there must be more cases where businesses are at risk of collapse, ergo it seems likely that more acquisitions that might otherwise have failed to gain clearance are approved. I don't want to oversell this point, but it's worth bearing in mind.
Incidentally, while I was looking for a separate article I found this piece from Aviva Investors which covers a number of the points I make above in more detail, and adds a few more.
Ownership + industry concentration to stay?
The combination of ownership and industry concentration was already attracting attention in public policy land. If the present crisis does reinforce both trends the issues that this raises become sharper. But I'm not sure that governments are going to want to unpick any of this or feel compelled to do so.
I've always felt that making anti-trust / pro-competition policy a centrepiece of a political programme feels a bit too abstract, despite the legitimacy of the points this would be intended to address. How many people get out of bed to campaign for 'challenger banks' for example? And who are the allies that they can count on. Arguably a capitalism dominated by a handful of big firms in each sector is better for reinvigorated bargaining by labour if that were ever to occur.
So on balance I think we are shifting to greater concentration and I don't think too many people will be motivated to do much about it.
Executive pay: aligned with who?
Onto more pure governance turf, I think changes to executive pay so far in the crisis deserve a look. As many people will be aware, the most common response from companies has been to cut base salaries for directors, with cuts around 20% of salary typical. The symbolism is pretty clear - many workers are furloughed on 80% of their normal salary, so the execs get paid 80% of their normal salary, or something similar. In some cases directors are also giving up or deferring bonuses, and in a smaller number of cases LTIP awards. Overall these types of changes have been generally seen as a good thing.
A question to consider here is how easy it will be to return to normal. For example, if an executive has taken a 20% pay cut during the furlough, is it ok to put the salary back to 'normal' once furloughing is over? What if the company has reduced its headcount? What happens when a bunch of companies push executive salaries back up? I can imagine some resistance to putting pay back to 'normal' levels.
But why not? If public companies are supposed to be run in the interests of shareholders, and this is justified on the basis that there is no conflict between different stakeholder interests and therefore those other stakeholders benefit from such a focus, why shouldn't directors continue to prioritise shareholders? Why are they aligning their pay with their employees rather than their investors?
The common sense answer is that companies understand that this is a moment at which it is important to prioritise employee safety. You could manufacture an argument that not doing this would be damaging to brands, and thus to profitability, and thus it's actually in the interests of shareholders to put employees first, for now. However I don't think anyone really believes that. But it does again raise the question of whether different interests are in conflict and, if they are, whose should come first.
Shareholder primacy paused
I've written elsewhere that I think shareholder primacy has been paused for the time being. For certain companies this is more obvious than others. For example, in a number of markets banks and insurers have been told to stop dividends, buybacks and payment of bonuses. Similarly in some countries those companies that are receiving state support are barred from such activity. In the first case, regulators seem to have adopted this stance to ensure that financial institutions are well capitalised, in the second it's more a question of ensuring that taxpayers are not subsidising investors.
Again, if there were no conflicts of interests this doesn't seem like it should be necessary. For example, banks would cancel dividends and buybacks because they knew they needed to do so to preserve capital and in doing so ensure they were delivering long-term value to shareholders. Actually, it seems that the UK's banks were not planning to scrap dividends before they were told to, and Standard Chartered was carrying on with its buyback right up the last moment. Does this mean that the PRA was wrong to tell them to stop?
An obvious retort is that this in an extraordinary situation and such moves might be politically necessary if not necessarily economically efficient. By which I mean simply that banks paying huge dividends and bonuses during a time of high unemployment might cause other, bigger problems. But is this only the case during a crisis, or is this just the moment at which we can see more clearly where the tensions are?
There was already increasing discussion of the merits of shareholder primacy before the pandemic hit. I think a shift back to arguing - explicitly - in favour of the model looks unlikely, though we might see lots of tortured arguments along the lines that actually lower dividends and no buybacks are good for shareholders. Therefore this might be another aspect of changed governance that endures.
Stakeholder alignment and pre-distribution
Finally, here's something I'm hoping for. I am glad to see Ed Miliband back in a frontline role, and shadow business feels like the ideal place. When we was Labour leader he toyed with the idea of pre-distribution even if there wasn't much flesh on the bones. Maybe now is the time to revisit it. Thinking again about changes to executive pay, a model of stakeholder alignment would surely put a much greater emphasis on profit-sharing and similar models whereby the entire workforce gains when the business succeeds.
It's always struck me as bizarre that there is more interest in putting 'employee engagement' targets into incentive schemes for executives than ensuring employees are engaged. Rather than paying A in a way that might incentivise them to ensure that B is engaged, why not just focus on how B is paid?
Once more, things were already moving in this kind of direction. For example, disclosure of pay ratios really wasn't driven by investor interests, and the data that is being disclosed is going to be used by a much wider set of stakeholders. So this does feel like an area where more is likely to happen. I know some people are already thinking about these kinds of issues, so let's encourage it. Let's make stakeholder alignment an objective in pay discussions from here on.
Finally, this in turn points to a different way of thinking about engagement. As I've written before I think a model which focuses on interactions between senior corporate staff and senior investment staff is flawed. This is the approach which spits out ideas like putting employee engagement KPIs in LTIPs because the conception is that is the strata that matters, and that is where the action happens, even if the bulk of the company is not involved. But again more later...
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