Monday, August 11, 2014

Institutional investors: whose side are they on?

Unpacking behaviour behind South Africa’s broad ownership of capital.

Be cautious when playing devil’s advocate – you might just qualify for the job. From the pile of CV’s being sent to the hot place many will no doubt come from journalists because it is a role they often play. But their mischief is tempered by the reality that they can never tell you what to think, only what to think about.

It’s different for academics and thought leaders. They shape not only the agenda but also the content in their teachings at educational institutions and their influence on socio economic perceptions. So when they add a touch of devil’s advocacy to their pronouncements, they should expect their media colleagues to take the bait.

One that has invited such a response is a Moneyweb article by the highly rated and my personal favourite economic myth buster, Mike Schussler (see article here). His finding that South Africans have one of the broadest ownerships of the economy in the world via pension funds, unit trusts, ESOPs, Trade Union investments, and broad based community ownership schemes will most likely lift a leftist eyebrow here and there and highlight a few behavioural conundrums.

One which Schussler raises is labour dissent which arguably hurts their capital interests. Other incongruities and questions include:

· Why the anti-capitalist rhetoric that overwhelms our economic and political debate?

· To what extent do the financial institutions who rely so heavily on employee contributions act in the interests of workers, and not the shareholders of investees?

· Why has this availability of capital from ordinary folk not helped in creating jobs, especially considering the large corporate savings of some R600bn?

· Why does broad ownership of capital instruments not mitigate concern about personal savings?

It is easy to write labour behaviour off to ignorance and powerful prejudices inherited from cold war ideologies and past legacies. That is only a small part of the answer. An important other part is that in this case ownership clearly does not mean control. The reality is that people’s views are mostly shaped by their experiences and one cannot deny that this capital ownership, including Employee share option programmes (ESOPs) has done little to involve them in the running of companies. The unemployed are automatically excluded.

At best, these institutional investments may give some comfort of a nest egg in retirement tempering the grudge deductions from pay. But this comfort is often shattered by the Fidentia’s of this world, or the more recent Transnet affair: that’s if this nest egg was preserved at all in the rapid turnover of employment. In addition, as Moneyweb reports, many beneficiaries are unhappy with their pension pay-outs.

One must also bear in mind that more than half of the R2.7 trillion pension assets are held on behalf of an overpaid and bloated civil service whose interests won’t be harmed by their own industrial action. The taxpayer simply foots the bill.

In our desire to condense everything into neat academic boxes we construct concepts such as “labour, capital, and state”, all interacting with each other in a predictable fashion from which we extrapolate theories, ideologies and immovable standpoints. The most vehemently defended is the supremacy of capital, the pursuit, ownership and accumulation of which accounts for prosperity and Milton Friedman’s “justice for all.” All other constituents, including labour and consumers, are commodities to be used in this process. To argue differently, even defending the ultimate supremacy of the buying public, and the axiomatic logic that supply exists to serve demand, automatically consigns one to some leftist leper colony.

The problem with these absolute abstracts is that they simply do not capture the humanity inherent in them all: individual behaviour shaped by values, dreams, fears, hopes, aspirations and expectations. To be sure, these are nebulous factors and way beyond the formulae of economists’ spreadsheets.

What cannot be disputed is that a growing number of people today, independent of ideological convictions, believe that capital has behaved rather badly in the last few decades. (See Moneyweb article here.) It is perhaps more than co-incidence that this has coincided with a spectacular increase in institutional investments estimated to be well over half of all investments globally. This has prompted Harvard and Yale academics, Benjamin Heineman and Stephen Davis (see joint paper here) asking whether institutional investors are part of the problem or part of the solution. Do they adequately advance the goals of individuals who gave them their money? Do they contribute significantly to undesirable “short-termism” or myopic behaviour in investees? This concern has also been raised in this Moneyweb article.

In addition one could ask whether they have encouraged or tempered excessive executive remuneration. With the relatively small individual benefits spread over millions of people and delayed for years to come have they not aggravated income disparities? By favouring large investees, do they not skew access to capital to big established and bloated corporates at the expense of SME’s and new risky investments? Are they not aloof, insensitive and not understanding of entrepreneurial genius and flair as was evident with Steve Jobs, Richard Branson and others? Do they not negatively impact on research and development?

The jury is still out on most of these questions and a vast amount of research is being done into this relatively new major force in capital formation. It has become clear that there are no absolute truths here and answers can differ depending on the institution, who it represents and the duration and size of its involvement. But what they all share are two very important features:

· They seldom if ever have a controlling interest in their investments making it difficult to have full sway on executive behaviour and

· Perhaps more importantly and understandably, their primary task is to ensure maximum returns for their funds or portfolios often posing a conflict of interest between those from whom they obtained funds, and those who use them.

Of course labour, especially in South Africa has behaved badly too. Both labour and capital suffer from the same myopia: pursuing maximum self-gain to the point of conflict between each other. When both doers and owners are so hell bent on maximising their benefit the ultimate victims are customers and wealth creation itself.

It is obvious that for the most part, broad public and employee stake-holding via institutions or ESOP trusts has not and will not motivate them to behave differently towards companies. Even less will it encourage involvement which is by far more important than incentive. For that, one needs a far greater degree of common purpose and common fate between the primary stakeholders. Essential to that is labour taking or being given behavioural ownership of their tasks and their part of wealth creation.

Until then the near inaudible lyrics of institutional investment may sound fine, but for many the melody is false.

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