Grassroot tycoons

Although the ownership of corporations may on the face of it appear to be increasingly concentrated, it's in fact becoming increasingly dispersed. The evolution of modern capitalism and savings is overseeing an unnoticed shift in the character of capital concentration. On the one hand there's a greater concentration of the capital "allocation" decision with institutional investors, the asset managers and life companies. On the other we're seeing a dispersion of capital "ownership" - considering that the capital is in fact provided by the wide array of savers from corporate, union, industry and State pension funds.

Allied with continued long-term growth in the global economy, there's been the accompanied growth in savings of the average worker. Those collective savings currently account for a significant component of global capital. Such pools of savers and shareowners with often-aligned interests are becoming the new - if somewhat distant - shareowners of today's corporations.

Hence an agent-principal problem is emerging with a set of challenges that still needs to be effectively addressed and dealt with. What's clear is that corporate owners now have a distinctly different character, face and ultimately interest to those wealthy families of yesteryear.

Davis, Lukomnik and Pitt-Watson consider these owners in the recently released book as the "grassroot tycoons" or the "new capitalists". As savings have broadened so, in reality, has the savings base. And what links these owners is their interest in the long-term sustainable profitability of their firms. As in the existence of a civil society so a new civil economy is emerging.

This civil economy, Davis and co argue, is the consequence of the constitutionalisation of the marketplace through the evolution of many new rules, standards and behaviours that effectively create voluntary and mandatory frameworks that redefine the role of boards, the requirements for transparency, the nature of share ownership and a number of allied aspects associated with modern capital markets.

The compelling issue is that those owners or new capitalists own shares in order to grow a savings base to match or offset a real liability that they have in the future. That liability is in most cases likely to be their income requirements for their retirement.

The interest of those savers may differ substantially from those of the historical owner/manager families and tycoons. Given that those grassroots tycoons represent the broader community or society in general they may place different priorities on value and have different timeframes with regard to corporate performance.

In their book published in 2000, Hawley and Williams initiated a discourse on the concept of the universal owner. They describe the "universal owner" as "a large institutional investor who holds in its portfolio a cross-section of the economy..." As such, they argued that such a large fund would ultimately hold an index portfolio; importantly, they argued that the universal owner's cumulative long-term return is more a function of the economy as a whole rather than simply the performance of each individual firm they own.

We'd argue that this universal owner and the grassroot tycoons are one and the same. Although those large institutions may on the face of it appear to be a single concentrated owner, in reality they're a collective, with the leadership acting in a fiduciary capacity to the ultimate owners - the fund participants.

What's of importance to those owners or fiduciaries is due consideration of the externalities - both positive and negative - related to the activities of the individual firm(s) and, ultimately, the impact such externalities have on other firms, the economy, the savers' implied liabilities and hence their portfolio.

As the idea of a universal owner is explored, the understanding of an externality is becoming increasingly relevant. Those "externalities" may well be benefits that accrue (such as the impact of improved education or local infrastructure) or a liability (poor quality air or toxic emissions into the environment that impacts on communities with consequent long-term health results).

The externalising of a cost, which may bring short-term benefits in the form of profits and surpluses for the firm (and hence the shareowner) may simply result in the creation of a longer-term liability elsewhere in the shareowner's portfolio, with another firm or within the broader economy.

Consequently, it can be seen that quite possibly the ultimate shareowners may now well place a different priority on the performance of the firm. Why? Because those owners - as citizens and taxpayers - will ultimately pick up the tab for externalised costs from companies seeking short-term profits.

Considering that in the context of SA trustees and institutional investors a recent survey highlights a disconnect between what's considered important (material) by the fiduciaries of those universal owners and their ability to effect the necessary change in their mandates. In the report the participants considered as material to the likely performance of their investments a number of environmental, social and governance factors.

However, when asked what the respondents were doing to incorporate those factors in their mandates - given their importance - most indicated that they were doing nothing or very little.

Trying to understand that disconnect the report explored the possible barriers. Most intriguingly, one of the key reasons for not exploring the incorporation of such material factors into their mandates was the perception that that would be in conflict with their fiduciary responsibility.

That barrier appears to be persisting to some degree due to the inferred relevance of a seriously misinterpreted British court decision in Cowan versus Scargill. This often-referenced case in trustee and fiduciary circles has been misunderstood and distorted by commentators over the years. Incorrectly, it's understood to support the view that it's unlawful for a board of trustees to do anything other than seek to maximise the profit for its beneficiaries.

To test the validity of that interpretation and explore the scope of fiduciary duties in a number of other key investment jurisdictions, the United Nations Environmental Programmes Financial Initiative (UNEP FI) commissioned a report to consider this important issue (the Freshfields Report). The essential scope and brief of the report was to determine if:

"[...]the integration of environmental, social and governance issues into investment policy (including asset allocation, portfolio construction and stock-picking or bond-picking) [is] voluntarily permitted, legally required or hampered by law and regulation; primarily as regards public and private pension funds, secondarily as regards insurance company reserves and mutual funds?"

The report concluded that, given that conventional investment analysis was focused on value and that there's clear evidence emerging of the materiality of environmental, social and governance (ESG) factors in determining value in a financial sense that the integration of ESG factors into investment analysis was "clearly permissible and [...] arguably required in all jurisdictions".

Putting that all together: Responsible investment and the Principles for Responsible Investment (PRI).

The case is beginning to stack up. Universal ownership seems to be aligning broad groups of shareowners with allied interests in relation to corporates, their conduct and performance. Clearly, the generation of economic profits is key for all owners: the only way they can meet their long-term liabilities. However, economic profits need to be real and should be achieved in such a way that they don't impose unsustainable externalities on the very owners to whom they're to deliver returns.

The emerging concept of RI provides a context within which that requirement fits. Recognition that "universal owners" have a real interest in the sustainable generation of profit by corporates speaks to the need for owners or their agents to start integrating the consideration of material issues, such as ESG factors, that may affect the true economic performance of their assets. Given the clarity provided by the Freshfields Report, such conduct by fiduciaries would be appropriate, if not required.

The case for adopting a more responsible approach to investments has been clearly made above. It reflects the broader interests of the new universal owners and represents an appropriate application of fiduciary responsibility.

However, the lack of response from SA and the lack of support from many institutional funds remains a mystery to many. There's no doubt that a part of the challenge relates to the diverse perspectives on the subject, the relatively poor educational efforts undertaken by the industry at large and the failure to find a unifying framework within which to place the many related areas of RI.

Fortunately, frameworks such as the UNEP FI Principles for Responsible Investment provide a useful and common approach for integrating material ESG issues into investment mandates and investment analysis. They support the evolution of universal owner networks and provide a context within which the exercise of fiduciary responsibility begins to take on a much more relevant character. The world of capital has changed and continues to change with the rise of the grassroot tycoons. These new capitalists have a very direct and vested interest in the responsible management of their assets. The integration of environmental, social and governance considerations that have a material impact on corporate valuations looks set to become increasingly relevant.

Our grassroot tycoons are turning the tables on the traditional interpretation and management of their assets, which is the logical and right approach. Shouldn't their desire to achieve the highest long-term sustainable returns relative to their future liabilities not be the ultimate fulfilment of a trustee or manager's true fiduciary duty?

Malcolm Gray

GRAY is Head of Client Service at Investec Asset Management. He is responsible for both the institutional and retail client service teams and is a member of the IMASA SRI task group and the JSE SRI advisory board, which provides independent oversight to the current JSE SRI.