Changing an Industry: The Fifty Trillion Dollar Man
Welcome to Innovation Ecosystem. I’m really pleased to have Colin Melvin as my guest today. Like many of our guest on these shows, Colin has led change and created something new. The difference with Colin’s Story is that his career for the last two decades has not been so much about changing a business, but changing an industry and this is not any industry. This is one that affects huge corporations in every sector across the globe. Colin is chairman of the equity ownership service side of London-based Hermes Investment Management and the head of its newly designated Stewardship project. In this role, he guides some of the management decision for $250 billion worth of corporate investments. If that is not a gargantuan enough figure to play with, Colin was the founding chairman of the United Nations Principle for Responsible Investment, an accord that now represents around $50 trillion of investment assets. Colin, it’s great to have you with us.
It’s a pleasure to be here with you. Thank you.
Let’s just take a few moments first for us to understand the role you and your organization play in the financial world. You don’t actually make investment decisions, but rather engaged these investment businesses to advise them on how they can collectively work together to influence their operations and activities of the businesses in their investment. Is that correct?
That’s right. Our decision is to engage with the company on behalf of this group of pension funds. Our clients at Hermes EOS are 45 pension funds and we engaged on their behalf in a collaborative way. It’s a bit like a coalition or a collaboration whereby the pension funds aggregate their shareholding in companies through us and we then apply resource which is greater than any one fund could afford. It benefits them all. The program is one of stewardship. That is stewardship of the company that’s owned by the pension fund, on behalf of the pension fund, and to promote good behavior by the company which should lead to better returns in the longer run.
These firms are extremely powerful, carrying the voting rights for billions of dollars of shares and different stock markets around the world. Why can’t they or don’t they want to make these decision themselves?
Well, they make the decisions collectively for a couple of reasons. One, they recognize that by working together they can do more. Even a very large pension fund tends to have a fraction of 1% of the shares of a very large company. But if they work together they can aggregate that through us into a large proportion. Maybe 1%, 2%, or 3%, depending on the size of the company. That gives them more opportunity for change. The other is that there is a tradition within the investment industry of spending money more on transactions on the buying and selling of things than on relationships. That needs to change. You could see the service that we’re providing is part of that change and it’s a shift in focus from the short-term to the long-term as well. Instead of focusing on short term transactional behavior, it’s more to do with the relationship with the company as shareholders but also the relationship that the company has itself with its stakeholders. Improving those relationships can lead to an improvement in the outcome for the investor, as well as the economy, society, and the environment, all at the same time.
The drive for that though is coming externally from the wider world, or is there something intrinsic within the pension funds that they want to do this?
I see this as kind of a societal shift. Around the time of the financial crisis, regulators in the UK and around the world realized that the banks that were failing and bringing down economies, or potentially so, had owners and shareholders and who were those shareholder owners? Well, they were us through our pension funds and our savings. There seemed to be a disconnect than between the interests of the underlying owner, the pension fund beneficiary, and the company that was owned, the bank and, indeed, the other companies that were owned and connected to that bank. That shift in understanding has been playing through since 2007, 2008, 2009 and has led to new regulations which encouraged pension funds to be better owners of companies and I think it’s alongside that a growing understanding in the public at large that we can’t continue to run the capitalist system the way we’ve been running it. It leads to very poor outcomes.
Large companies that we all invest in through our pension funds are involved in bribery and corruption, environmental degradation, child labour, or modern slavery in some cases, avoiding paying tax. All of these things are, to some extent, in our name and presumed to be a benefit to us because they maximize the short term value of the shareholding. That’s just a very poor outcome because of course, pension funds invest for the long-term and with a pension fund with 20–30 year liabilities, shouldn’t be concerned about the short term performance of the companies they invest in.
I think there’s are a shift in understanding with that disconnect. It’s what I would have called in my early career as a historian, a hegemonic shift. A shift in the language and the ways in which we understand our jobs in the investment sector, which is leading to more of an engagement with the companies, less of a transactional focus. That’s the reason we have the service and we set it up 11 years ago here but it’s really growing quickly now. We’re getting a lot of big pension funds coming to us, asking for us to help.
It’s interesting. There seem to be two pivots there. One; the short-term, long-term balance that you’re trying to shift them towards. Two; this societal change that you recognized between the transactional and relational interactions. I’ve never really thought about it before — there’s a big connection between those two things and the relationships ought to be longer term and transactions are instantaneous. They’re one-off. So there is a connection there, isn’t there?
Yes. I think so. Most of the dysfunctionality within the investment system arises from short-termism of one kind or another linked to transactions. It is extreme, of course. You’ve probably heard of ‘dark pools’ and ‘high frequency trading’ and so on, which really doesn’t have any social utility but it still happens. It often happens with money that you and I and many others in the economy and society have invested. So it seems that we’ve created a transacting machine in the city and in Wall Street, which transacts at a frequency which it can determine, and which transactions it benefits from, because it’s paid fundamentally for the transactions. Where the proper functioning of the financial system and the investment markets should be the allocation of capital efficiently and effectively within the capitalist system, within our economy, to sustain and enable development and growth of the companies that we save through and work within.
There’s a problem there and, as I said, we then need to shift our focus from the short-term transactional behavior to longer term relationships. It’s not that there shouldn’t be any transactions; of course we still need to transact. But it’s a question of what’s important and what we focus on. If we can encourage the large companies that we all invest in for pension funds to have better relationships with their employees and their suppliers and their customers, and indeed the shareholders and other stakeholders. Those improving relationships lead to the improvement in the value of the firm over time and that’s, I think, a much better understanding of how value is generated within the new economy.
Are the pension funds in a position to instruct the asset managers, their investment managers to transact less? Does the governance of the pension fund cover that? Because it seems to me that the transaction side is very driven by the City, the tradee approach.
It’s really a situation of supplier controls. The clients of the city, by and large, take the terms offered to them. There’s a lot of tradition here and the assumption is that this is the right way to behave. As I say, I think people are saying that these need to shift, but the tradition is that money is managed on a short-term basis. Even if the pension funds gives a mandate a year or so to the fund manager, often the fund manager is concerned about that contract being terminated at short notice, relative to short-term, poor investment performance and that performance is measured quarterly. As you’re aware, many companies that provide quarterly reports to sustain this approach.
Again, you have this short-term approach within the relationship between the investor and the company which is detrimental to corporate success. If you’re the chief executive or finance director of a medium to large company in the UK, for example, your experience of talking to your owners, the shareholders is really not very good. You find you’re talking to people who are far more interested in getting information about next quarter’s earnings than they are about the people in the business or the longer term strategy and so on. That’s such a huge missed opportunity because, of course, our fund managers are often very knowledgeable, well-educated people and many of them could do a job which is far more interesting and useful than they’re presently able to do. In some ways, it’s a return to the way investment used to be which was far more relational than it is presently.
No, I see that completely. That’s clearly all tied in with this ESG investing — Environmental, Social, and on the, Governance side. This underlined the Principles for Responsible Investing at the United Nations that you were a co-author in putting together part of that 10, 11 years ago.
11 years ago, yeah. The 10th anniversary was just a couple of weeks ago.
Oh, alright. Congratulations.
That is focusing on more active ownership with this wider societal sense to it. Where did the drive from that come from? Was it from within the finance industry or were you having to change, UNPRI and yourselves, having to re-educate, change the pension funds themselves from the status quo that they’re currently in?
Well, there’s a small group of about 25 funds involved in the initial phase of this. Going back to 2004 or 2005 when we drafted the principles and they were based on a set of principles that the United Nations, which focused on companies, called the UN Global Compact. This is a set of 10 principles for companies around their behavior and, at least, the treatment of the workforce environment, human rights, more broadly. The UN Global Compact was very successful. It now has 8,000 companies signed up to it and most of the world’s largest companies have committed to these principles. So, it’s a very significant initiative and so what we wanted to do is to bring something in similar for the investment world. If we could find some principles for responsible investment, which is what they’re called, then that might benefit the investment and the economy and society more broadly.
There are six principles of the PRI. The first two are the most significant, I think. The first one really incorporates what’s now known as ESG, as you said environmental, social, governance factors into our investment decision making. This means more qualitative rather than purely quantitative analysis. The second is we’ll be good owners of the assets that we invest in, on the understanding that good ownership or Stewardship as it is now known will lead to a better outcome. You’re engaging with companies at a very senior level to get a change where change is needed to improve their performance over time.
I’m really interested in that change. What you are doing is trying to create change through these principles, but in getting the principles in place in the first place would have required a great deal of change. I think what’s fascinating about this story is that you were operating at a huge global level. You were trying to create industry or ecosystem-wide change and the United Nations allows, provides a platform for that but you’re therefore dealing with the heads of very large organization, country-level diplomats. When you started, from you, personally, were you aware of what it would take to have these conversations and persuade people?
It’s a compulsion for me. I tend to find myself, or have done in my career, in positions getting people to work together; resolving conflict or finding ways in which we can do better by bringing different people from different perspectives. My involvement to this, in this area, goes back some 22 years. I was at Standard Life Investments in Edinburgh early on in my career and I trained as a fund manager and qualified as a fund manager. Very early on, I realized that there was something more interesting happening, which was that there was this new field at the time of corporate governance emerging which describes the relationship between companies and shareholders. That just seemed to be way more interesting than the short run financial analysis that we were involved with. It was that understanding that the opportunity to bring shareholders and companies together, which I took into the UN Project. The most interesting principle for me is that second one, the link between the shareholder and the company as well as the longer term perspective that’s required.
In terms of the funds themselves involved, the changes that you want to be part of are changes that want to emerge. This is not something I’ve created myself but rather tuned into; I gained an awareness that there was a group of leaders within the investment industry who wanted to see a change. This change has not yet happened. Though its ten year anniversary has just come and gone, the PRI represents a huge potential for change, which is still, I think, largely unrealized.
But wait…there’s more?!
This post has been adapted from The Innovation Ecosystem podcast. Listen here for the full interview and the story of Colin Melvin and to download a PDF version of this entire conversation.
Mark has spent much of his 20+ year career seeking out people and resources to help him innovate and grow businesses. He has worked at BP, The Hay Group , and most recently Syngenta, where he led the creation and development of a $2B Specialty Crops business unit. Wherever possible, he tries to learn from other people’s experience, especially if they bring a fresh perspective to a situation. Follow Mark on Twitter at @markehb.
Roddy Millar is the Co-Founder and Managing Editor of IEDP (International Executive Development) and has managed the editorial content and direction since its inception. He oversees the development of the website and has helped design and launch Developing Leaders magazine, as well as managing the financial aspects of the business. In 2000 Roddy took over as editor of the original International Executive Development Programs directory from Philip Sadler CBE, the former Chief Executive of Ashridge Business School. Follow Roddy on Twitter at @RoddyMillar.
We welcome your comments.