31 August 2006
Fake Owners
On 27th August the Sunday Times included an excellent article by Nicholas Berry under the headline "Fake Owners are ruining capitalism". The article is available at http://www.timesonline.co.uk/article/0,,2095-2329967_1,00.html
The point that Nicholas Berry makes is that for many listed companies the major owners of shares are pension funds, investment trusts, hedge funds, unit trusts and the like. He calls these "fake owners" because the people making the investment decisions are not the people whose money is at risk. Fake investors make their money from selling their services as investment managers. Unlike real owners, they are often not concerned about whether a particular business investment will prove to be a success or failure in the long term. They are much more concerned about the short term performance of the share price and making themselves look good as investment managers.
This is a huge problem with capitalism as we experience today. There is great pressure on business managers to meet the short term needs of fake owners. This detracts from management's ability to focus on the long term growth in business value which is what ultimately matters to end investors and to society as a whole.
The proper incentives to manage executive pay also arise from a concern for long term value creation. Fake owners find it much easier to collude with a culture of high executive pay, because they themselves like high pay and because they are not personally damaged by the negative long term effects of overpaying executives.
All of us who hope to live off pensions or savings in the future are dependent on a healthy environment for business ownership and efficient capital allocation. Without a healthy investment environment the value of the investments that underwrite our savings and pensions will be seriously damaged in the long term. We therefore need to champion real ownership and try to minimize the influence of fake owners. Here are some suggestions for how this can be done:
1) Invest in simple financial products that select good businesses to invest in and invest in them for the long term.
2) Avoid investment products that pay high fees to the investment managers.
4) Only accept performance payments to an investment manager if the performance is measured over the long term. An investment that makes a good return four years out of five, but a serious loss in the fifth year should not get any performance payment.
5) Ensure that the fund manager can never receive commission payments directly for decisions about how your capital is invested. Hedge funds sometimes pay managers a proportion of the commission associated with stock leading. If the manager is influenced by this commission it means that the best interests of the investors is taking second place.
6) Encourage your pension fund trustees to follow these principles.
The point that Nicholas Berry makes is that for many listed companies the major owners of shares are pension funds, investment trusts, hedge funds, unit trusts and the like. He calls these "fake owners" because the people making the investment decisions are not the people whose money is at risk. Fake investors make their money from selling their services as investment managers. Unlike real owners, they are often not concerned about whether a particular business investment will prove to be a success or failure in the long term. They are much more concerned about the short term performance of the share price and making themselves look good as investment managers.
This is a huge problem with capitalism as we experience today. There is great pressure on business managers to meet the short term needs of fake owners. This detracts from management's ability to focus on the long term growth in business value which is what ultimately matters to end investors and to society as a whole.
The proper incentives to manage executive pay also arise from a concern for long term value creation. Fake owners find it much easier to collude with a culture of high executive pay, because they themselves like high pay and because they are not personally damaged by the negative long term effects of overpaying executives.
All of us who hope to live off pensions or savings in the future are dependent on a healthy environment for business ownership and efficient capital allocation. Without a healthy investment environment the value of the investments that underwrite our savings and pensions will be seriously damaged in the long term. We therefore need to champion real ownership and try to minimize the influence of fake owners. Here are some suggestions for how this can be done:
1) Invest in simple financial products that select good businesses to invest in and invest in them for the long term.
2) Avoid investment products that pay high fees to the investment managers.
3) Seek to invest in large funds, so that the cost of management is small compared to the size of the fund. Insist that the savings are passed back to the investor.
4) Only accept performance payments to an investment manager if the performance is measured over the long term. An investment that makes a good return four years out of five, but a serious loss in the fifth year should not get any performance payment.
5) Ensure that the fund manager can never receive commission payments directly for decisions about how your capital is invested. Hedge funds sometimes pay managers a proportion of the commission associated with stock leading. If the manager is influenced by this commission it means that the best interests of the investors is taking second place.
6) Encourage your pension fund trustees to follow these principles.
