Friday, 19 July 2019

Dividend trades and voting

Obviously, I've not been blogging much lately, but something I've been spending a bit of time looking at is dividend arbitrage. In it its most well-known version, this is the practice of shifting stock around the ex dividend in order minimise tax payable. There is a variety of different trades, and at one end of the spectrum some of them are the subject of legal cases. (great piece on Macquarie's involvement here).

What all of them involve is stock lending. I recommend having a read of this paper from Richard Davies IR, which opened my eyes to the scale of lending that is going on in the UK. 20% to 30% of stock is going out on loan around the ex dividend dates of major UK PLCs, which immediately makes me think about the potential governance impact.

It's very hard to pin down who is involved. But one thing that can happen with large movements in stock is that they trigger regulatory announcements because voting rights thresholds are crossed. These are are the TR1 notices, which appear with the title "Holding(s) in company" if you look on sites like Investegate.

So one of the things I did was look at TR1 notices issued around the ex dividend dates of a few companies. And I can see some, Blackrock in particular seems to be triggering them on a regular basis. These appear to show a shift in allocation of voting rights a few days before the ex dividend date and back again a few days after it.

Where it gets particularly interesting is when the ex dividend date is close to the AGM. If this shuffling of stock involves lending some to another party then there *might* be an impact on voting turnout if shares aren't returned in time to vote. I have identified cases where voting turnout has gone down (very significantly in one of them) when the ex dividend date has been close to the AGM date.

I can't say for certain if the stock-lending is a) linked to a dividend trade or b) resulting in lower voting turnout. But it's a bit of a coincidence.

Thursday, 18 July 2019

Out of touch, out of mind

Something I've been thinking about a bit lately is how disconnected responsible investment is from the rest of the world. There is a tidal wave of marketing for ESG products and services currently storming through the financial services industry, yet it still feels distant from society.

I've also been re-reading a lot of Zygmunt Bauman and realise just how well he articulates a number of issues that trouble me. So I thought I'd try and combine the two - the excerpts quoted are from Globalisation: The Human Consequences, which is over 20 years old and well worth a read.

To start with a specific example, I spent a lot of time looking at Ryanair over the last few years. I have had countless meetings, calls etc with investors and advisory services over the period. At the same time it was obvious that the company was going through a very difficult time in respect of labour relations.

Yet, despite this, the amount of proactive contact from investors seeking to understand what was going on was limited. I can think of a couple of asset managers that were more on the ball, plus a couple of research/advisory houses. Arguably the most interested (and certainly the most knowledgable) were mainstream sellside analysts who were purely focused on potential financial impact, rather than ESG factors.

I also know there was significant engagement (some of it collaborative) going on between some shareholders and the company, including on labour issues, but without including the company's workforce itself. I come at this with a very specific background, but I find it hard to comprehend that anyone can think they are engaging meaningfully with a company about workforce issues without also at least trying to talk to members of that workforce.

This suggests to me a conception of engagement within the investment industry which involves senior people on the corporate side talking to specialists from asset managers. My gut feeling is that this is likely to lead to a very one-sided view of issues. For example, an investor might read a media report about employee complaints about precarious work at a given company, they might engage with the company and get the response that "it's complicated than that, and many workers like the flexibility" and basically be happy with that.

To take one specific example, I came across an interview (published before the labour crisis hit) where someone from Robeco claimed that Ryanair's employment model was a good thing for younger workers. Yet the nature of employment contracts was one of the animating issues amongst striking cabin crew just a year or so later.

Cue Bauman:
"What looks, however, like flexibility on the demand side, rebounds on all those cast on the supply side as hard, cruel, impregnable an unassailable fate: jobs come and go, they vanish as soon as they appeared, they are cut in pieces and withdrawn without notice while the rules of the hiring/firing game change without warning - and there is little the job-holders and job-seekers may do to stop the see-saw. And so to meet the standards of flexibility set for those who make and unmake the rules - to be 'flexible' in the eyes of investors - the plight of 'suppliers of labour' must be as rigid and inflexible as possible - indeed the very contrary of 'flexible': their freedom to choose, to accept or refuse, let alone to impose their own rules on the game, must be cut to the bare bone." 
If your views about the state of industrial relations at Ryanair, and the likely impact of strikes, were formed principally on the basis of engagement with the company I think you'll have had an uncomfortable 2018. In fact there was money to be made betting against the company's narrative during the period, and to my knowledge at least one hedge fund successfully did so.

A related aspect of the RI industry that makes it feel detached from society is its global nature. The increasing consolidation of the asset management industry (which we can only expect to continue, especially with the growth of passive management) means that the organisations that responsible for policing these issues are the UK outposts of global giants. Asset managers increasingly advertise their  global reach, including in engagement on ESG issues. There is also an international conference circuit (PRI, ICGN etc) that quite a few ESG people are part of. This points to an emerging globalised class of ESG specialists.

Yet beneficiaries remain resolutely stuck at a local level. On the one hand, most people have no expectation of international travel as part of their job. Asset managers jet across the world to speak on panels about stakeholder engagement and human capital management. That 'human capital' itself, however, cannot attend or have representation.

On the other hand, the way that globalisation affects employment is likely interpreted in a very different way. The relocation a job to a different country might present an exciting career opportunity to someone in finance, whereas it means a P45 to someone in a call centre or on a production line.

Bauman again:
"The fashionable term 'nomads', applied indiscriminately to all contemporaries of the postmodern era, is grossly misleading, as it gloss over the profound differences which represent the two types of experience and render all similarity between them formal and superficial.
As a matter of fact, the worlds sedimented on the two poles, at the top and bottom of the emergent hierarchy of mobility, differ sharply; they also become increasingly incommunicado to each other. For the first world, the world of the globally mobile, the space has lost its constraining quality and is easily traversed in both its 'real' and 'virtual' renditions. For the second world, the world of the 'locally tied', of those barred from moving and thus bound to passively bear whatever change may be visited on the locality they are tied to, the real space is fast closing up." 
Just to be clear, I'm a Remainer, I live in London and really enjoy living in a global city. But I also feel the pull of the 'local' and as such some of what I see in the field in which I work troubles me.

Bauman makes repeated reference to the fact that one factor - capital - has no spatial limits. (Indeed attempts to impose any, to limit mobility or liquidity, are guaranteed to generate the strongest rebuke from the finance sector.)
Among all [those] who have a say in the running of the company, only 'people who invest' - the shareholders - are in no way space-tied; they can buy any share at any stock exchange and through any broker, and the geographical nearness or distance of the company will be in all probability the least important consideration in their decision to buy or sell.In principle there is nothing space-determined in the dispersion of the shareholders. They are the sole factor genuinely free from spatial determination. And it is to them and them only, that the company 'belongs'. [well, not really, but...] It is up to them therefore to move the company wherever they spy out or anticipate a chance of higher dividends, leaving to all others - locally bound as they are - the task of wound-licking, damage-repair and waste-disposal. Whoever is free to run away from locality, is free to run away from the consequences. These are the most important spoils of victorious space war.  
We have to be clear now that it is 'our' own pension funds, increasingly shorn of member control or representation ('good' governance in this world means technocratic efficiency, not democratic accountability) that are often in the mix. 'Your' pension fund may have been built up over a few generations from the deferred wages of workers from your area, but don't have any expectation that it is accountable to you. Even when it is active on ESG issues it is likely to be in pursuit of objectives that align little with the interests of workers in the local area, whose labour created the assets that are being utilised.

Finally, the recent expansion and development of the RI industry has increased both complexity and obfuscation. In the current environment there is almost no way for a non-specialist to make sense of who the 'good guys' are. Every manager can offer you an ESG product, even if most people have no expectation of understanding how it differs from any others, or whether it really makes a difference. Some firms/services (Morningstar etc) seek to 'rate' them, but these ratings must in turn be based on a view of what matters - and how many ordinary punters will ever seek to understand fund ratings methodology?

The net result is likely to be (as with financial services in general) that a lack of understanding on the client side results in an unaccountable sector that is able to set its own terms. We expect these firms to act as 'stewards' of companies but without any realistic expectation that they can themselves be held accountable. Does this sound unrealistic? Three words: Woodford Investment Management. Look how long it took for even sophisticated clients to realise something was wrong and kick up a fuss. Some in the system who ought to be released upon by the unsophisticated did not even have the incentives to make a noise. Something similar seems very likely to happen in RI land at some point.

More when I can summon up the energy...

Sunday, 19 May 2019

Workers on boards: high-risk inaction

Over the past few weeks there has been quite a lot of interest in the extent to which UK companies are giving employees a say in corporate governance. As most people will know, the revised UK Corporate Governance Code that came into force this year encourages companies to say/do more in respect of 'workforce engagement'.

Although Theresa May originally said she wanted workers on the boards of all companies, the revised Code actually offers three options - a worker director, a NED nominated to handle workforce engagement, or a workforce advisory panel.... or some other  mechanism chosen by the company, or explaining why you don't comply.

Once this fudge (which was supported/encouraged by some investors) was put into the Code, everyone's expectation was that the large majority of companies would choose the nominated NED option. With a handful of exceptions that is what has happened. Capita, Mears and Sports Direct have all appointed employee directors, but the large majority of PLCs have indeed just tagged a NED. There are some really awful examples out there - like Mediclinic, which appointed its former CEO as the NED responsible for workforce engagement.

Unsurprisingly, this outcome has led to some criticism in the press including both the Mail on Sunday and the Independent. The basic message is that companies have resisted change and have made a mockery of the original idea.

I think this outcome, whilst hardly unexpected, is probably the worst thing that could have happened for all concerned. I actually think that in the medium- to long-term opponents of employees on boards have most to fear, but more of that in a minute. There are (at least) three key reasons why this outcome is bad. First up, employees have denied an historic opportunity to have a voice in the governance of organisations where they spend a large part of their life. Second, boards have made it look like they are resistant to change and/or aren't too fussed about workforce engagement. Third, it makes the UK Corporate Governance Code look ineffective.

On this last point, it's notable that the FRC saw this potential outcome a long way off. Here's Stephen Haddrill in front of the BEIS committee a few years back:
The full-blown worker-elected director model should not be done through the corporate governance code. That is quite a big shift and requires parliamentary weight behind it to get it done. There is a risk if we try to do it through the code that we would have a very high level of non-compliance. That would cause the code to come into some discredit.
Well, that's just happened, hasn't it? I would add to this that we should not expect that monitoring of the Code on this point is likely to lead to any change. Many asset managers are unconvinced about or opposed to employee voice in corporate governance, so they are unlikely to be pulling companies up for nominating a NED instead of appointing employee directors. 

This is part of the reason why I think this outcome is actually *bad* news for people who really want to stop this policy. A bit more willingness to play ball on the part of PLCs might have convinced people that a 'let a thousand flowers bloom' was a reasonable approach to take. But the fact that the overwhelming choice is to stick with the status quo makes things look very different.

I don't think any future government that is supportive of employee voice is going to look at where we are and think PLCs have really picked the best or most appropriate model. I think they are more likely to conclude that a corporate foot-dragging, unchallenged or tacitly encouraged by asset managers, is a block on progress.

They are also likely to think that using the UK Corporate Governance Code to implement employee voice is ineffective. This makes it more likely that employee representation is sought through a change in the law. This would (obviously) be a significant shift away from 'comply or explain' towards a regulatory approach to governance. But current practice seems to point towards this kind of conclusion.    

Sunday, 12 May 2019

Monopoly industries, monopoly owners

One of of the things I find myself spending time reading and thinking about lately is the interaction between concentration of companies (or oligopoly) within industries, and concentration of ownership of those same companies.

There have been a number of books in recent years that look at growing industry concentration. Cornered by Barry C Lynn and The Myth of Capitalism by Jonathan Tepper and Denise Hearn are the two I've been reading recently. Both tell a similar story of how the number of companies within a number of industries has become increasingly concentrated, undercutting the proposition that actually existing capitalism is really all about competition and innovation.

US airlines are often cited as an example where there is a very limited number of companies, with de facto regional monopolies. Lynn provides a bunch of other interesting examples, like the domination of opticians by Luxottica, a company most of us have probably never heard of. Or try buying certain products - in person, rather than online - without going to Walmart (online, obviously, Amazon dominates). He describes this as Hydra-like - multiple heads on the same body - which is a nice way of describing it.

So far, so familiar. But what both books, and others I've been reading, also focus on is the concentration of ownership of those monopolies. For example, Tepper and Hearn cite research showing that in 1980 if you paired any two US firms 75% of them would have no common shareholder. By 2012 that figure had dropped to 8% (which actually sounds quite high to me).

Obviously the growth of passive investing, and therefore the growth of passive managers, is a major part of the story. For example, the proportion of shares of the S&P 500 held by the Big 3 - BlackRock, Vanguard and State Street - has risen from 9.1% in 2002 to 18.4% in 2018. Between them hold roughly 15% or more of all the big US banks. And we can see similar things at work in other countries, if not quite so pronounced.

But why does it matter? There are differing views on this in the books I've been reading, so here are a few arguments.

1. There's a risk that concentrated/cross-ownership of oligopolies reduces competitive pressure even further. Here's a take from the Left (from The People's Republic of Walmart):
"An investor who has holdings on one airline or telecom wants it to outperform the others: to increase its profits, even if temporarily, at others' expense. But an investor who owns a piece of every airline or telecom, as occurs in a passively managed index fund, has drastically different goals. Competition no longer matters; the overriding interest is squeezing the most out of customers and workers across an entire industry - no matter which firm does it. In principle, capitalist competition should unremittingly steer the total profits across a sector dow, ultimately to zero. This is because even though every firm individually aims for the highest possible profit, doing so means finding ways to undercut competitors and thus reduce profit opportunities sector-wide. Big institutional investors and passive investment funds, on the other hand, move entire sectors toward concentration that looks much more like monopoly - with handy profits, as firms have less reason to undercut each other."
Tepper and Hearn make the same point:
"Concentration of ownership is problematic because it distills the control of entire industries into a few players' hands. But even more concerning is that recent studies are suggesting that common ownership incentivises firms to avoid competing with each other altogether... In a situation with horizontal share ownership, where firms are trying to please the same owner, firms can tacitly collude to maintain high corporate profits by swelling total industry performance. Investors make money when the industry (not individual companies0 makes money. The easiest way to do this is to raise consumer prices."
They go on to use the example of US airlines and banks where concentrated common ownership is correlated with increased prices / fees. They also suggest that industries with concentrated  common ownership tend to invest less and spend more on stock buybacks.  

2. Barry Lynn argues that the shift to indexing puts more power back in the hands of corporate leaders:
"[T]he mutual funds socialised the small investors' ownership stake by broadening it to the point of destroying any sense of common interest between the average small investor and any one company. As a result... the real power shifted way from us to the fund managers and the financiers, who supposedly did our bidding but who instead used our gold to forge the fetters with which to bind us."
3. What about intangibles? A really interesting line of argument comes from Jonathan Haskel and Stian Westlake in Capitalism Without Capital.  They argue that highly diversified investors will be more open to investment in intangibles that has spillover effects, as they own all the shares in an industry and thus while value might be lost in the firm making the investment, it is gained by those taking advantage of it. But they also point out that diversified means thinly spread, so only those with concentrated ownership will have the incentives to put the time in to understand and value intangible investment.
"The greater uncertainty of intangible assets and decreasing usefulness of company accounts put a premium on good equity research and on insight into fund management. This will present a challenge to investors, partly because funding equity research is becoming harder for many institutional investors as regulations are tightened, and partly because of the inherent tension between diversification (which allows shareholders to gain from the spillover effects of intangible investment) and concentrated ownership (which reduces the costs of analysis)."
Of course, as outlined earlier, what we see with the growth of passive management is the combination of diversification and concentration. Passive managers are often the largest shareholders, and as a block hold a major chunk. In such a scenario my strong feeling is that the diversification aspect is going to easily trump the theoretical reduced research cost.

Think how much more research would cost on all the stocks where BlackRock is a major (say 5%+) shareholder. And while you are thinking about that, also consider the price war on index funds. Blackrock uses stock lending to keep its fees low. Vanguard uses 'heartbeat trades'. I've seen some examples where passive managers are almost giving the product away to big clients. These do not look like firms that are going to spend a lot of money on research. Which is why I asked previously what business some asset managers are actually in.

Of course there will always be active managers out there which take big positions and do the research. But overall they are going to be outweighed by the assets of low-cost index-trackers. I don't see widespread quality analysis of intangibles emerging from this any time soon. If there's no encouragement to invest, because there's an oligopoly in the industry and firms can find other ways to make money, and investors are unlikely to do the research that would put a value on intangibles anyway, well....

For my part, my gut feeling is that, overall, the rise of indexation results in less scrutiny of public companies, certainly over business-critical issues. BlackRock's role in Carillion was a good example here, where it engaged over remuneration with a business clearly facing an existential threat. As such I'm drawn to Lynn's argument that the net result is a re-concentration of power in the hands of corporate leaders.

I actually think that's OK on one level. If we want cheap way to get equity returns, then low-cost passive funds are a good option. But I think that we ought to question why asset managers need to be involved in voting and engagement at all in such a scenario. If you're holding UK stocks purely because they're in the FTSE, why do you need to follow what Larry Fink's team's views on, say, how much the directors should be paid?

But that's another story...

Thursday, 9 May 2019

Infrastructure investment politics

I was interested to see a piece in City AM recently from Robert Colvile of the Centre for Policy Studies about Labour's plans for nationalisation of utilities. I'm interested in this issue as it cuts across politics and ownership, which is, obviously, right up my street. The CPS has previously issued a report containing some very large figures about the costs public ownership, authored by Daniel Mahoney.

What caught my eye in the City AM piece was this stray line:
It would also rip off the 5.8m UK pension pots that the Global Infrastructure Investment Alliance has calculated are invested in the water industry – as well as millions more in the energy grid, Royal Mail, the trains, and so on.
I am dimly aware of the GIIA due to having done some work on infrastructure investment. So I had a quick trawl of its website to see if I could find a source for this stat. That can be found here, but I also found this announcement:
  • Daniel Mahoney joins as Senior Policy and Research Adviser from one of the UK’s leading think tanks, Centre for Policy Studies (CPS). In his role as Head of Economic Research he has authored a number of reports and articles on infrastructure related topics. Prior to this role, Daniel was a senior researcher at the House of Lords and for the Global Warming Policy Foundation.
Useful to know.

Funnily enough, last month London First ran a piece attacking Labour's public ownership plans in City AM which included an interesting stat:
Pension funds have a clear stake here. There is no doubt that many UK pension pots would be affected by a proposal to renationalise on the cheap. Data from the Global Infrastructure Investor Association shows that 7.67m pension pots would be exposed to losses in sectors that could be put back into state hands under a Labour government.
And by coincidence, London First's Programme Director for Infrastructure is Daniel Mahoney.

None of this is inherently wrong. Everyone involved in policy / politics does this kind of thing to some degree. Just most of the time the links aren't quite as obvious.

Monday, 6 May 2019

Corporate governance, again

There have been a few developments over the past week or two that play into the argument I've been making that 1990s-style corporate governance is come under serious pressure to change.

1. Polling from the resolutely centrist Progressive Centre UK, which found strong public support for policies like a mandatory maximum worker-to-CEO pay ratio, caps on bonuses, workers on boards etc. 

2. A report out today from the High Pay Centre shows that shareholders in UK companies are *still* not using their legal rights to control executive pay.

3. Research by LAPFF found that the large majority of companies are choosing NOT to appoint worker directors to their boards.

4. The launch of the ace-a-tronic Common Wealth, which is going to focus on questions of ownership in various fields.

You can pull this all into quite a coherent picture: the public thinks executive pay is too high; shareholders have been given powers to tackle it but don't seem willing and/or able to do the job; companies have been encouraged to give workers a say at board level, which might help tackle it, but have stuck two fingers up in response; as a result public policy experts are looking at other more radical interventions.

As I've said before, I think we can see the bones of an alternative approach to corporate governance. It's primarily come from the Left, but I think it is rapidly becoming 'common sense' across a large range of people who look at policy in this area. To repeat it, I think we're looking at a shift away from shareholder primacy (so more action on corporate purpose, perhaps legal changes to directors' duties), stakeholder representation in corporate governance (workers on boards etc) and more diverse forms of ownership (again, a greater stake for employees looks to be pretty central).

Again I'm repeating myself, but at the 'ideas' level, things seem to be moving pretty quickly. I was genuinely surprised at how far Chuka Umunna's pamphlet went on issues like co-determination and employee ownership, for example. And I recently stumbled on this speech by the head of the New Zealand financial / capital markets regulator explicitly arguing against shareholder primacy.

Something is up.

Thursday, 2 May 2019

The loyalty 'penalty'

A few months back I blogged some initial thoughts about the idea of loyalty. To recap, I find it jarring that various bodies increasingly try and encourage us to be disloyal. While I get that it's silly to be 'loyal' to a utility provider (or insert your own product/service provide), there's something about encouraging disloyalty that feels weird.

As I've blogged previously, if you look at moral foundations theory loyalty is one of the core pillars, though apparently it resonates a lot more with 'conservative' people (this obviously assumed you have confidence in any psychological research, which is a question for another day). So I am not at all sure that telling people that loyalty is stupid - basically what Which? and others say - is going to make them 'disloyal'. I think they will just become cynical about providers.

piece by Jonathan Ford in the FT this week covers similar ground and adds a couple of points that are worth clocking. He notes that there is now even a term - the 'loyalty penalty' - for the way that providers screw over long-term customers by offering them poor deals (indeed this is language the CMA uses). He says the scale is vast - an estimated £4bn a year - and that the worst offenders are in concentrated/oligopolistic markets. Interestingly he also links it to the need to keep financial stakeholders onside, at the expense of others:


Whether you agree with that or not, it's hard to argue with the conclusion that the net result is further damage to the reputation of those businesses involved, and to belief that the market can sort it all out.

To circle back, this is why I find the "don't be loyal" messaging by the likes of Which? a bit odd. It feels like it's saying it's your own stupid fault if you trust providers, of course they are going to try and scalp you. And that the responsibility is on you to avoid getting ripped off, rather than on the provider to not to try and rip you off in the first place. And combine that with monopolies like utilities, where "shopping around" just means choosing a different logo on your bill. I have to choose between one of these firms, but I can't rely on them not to rip me off, so I should assume I will have to engage in a tactical battle of regularly switching with them to avoid it, even though the product I receive at the end is the same.

As I blogged last time, I don't believe that faced with all this people are going to think that it is their 'loyalty' that is a bad thing, I think they are going to conclude that the system is a swindle. Arguing for regular switching in terms of not being loyal is going to feed a sense of distrust. It's only going to increase support for radical intervention, be it tighter regulation or changes to the nature of ownership.