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Note: Hermes Equity Ownership Services, the subject of the article below, had supported the organization of the Forum's 2006 program addressing executive compensation issues, and is now represented on the Forum's current Program Panel addressing "Say on Pay" issues that developed from the earlier program.


Financial Times, January 11, 2009 article


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Regulation and Governance

Long term ‘engagement’ for a stable system

By Sophia

Published: January 11 2009 21:07 | Last updated: January 11 2009 21:07


Colin Melvin, chief executive of Hermes Equity Ownership Services, is in the pleasant position of running a business that is not required to produce profits. “We need to be able to cover our costs,” says Mr Melvin, “but the value we add for [owners] BT Pension Scheme is so far beyond any profit we might make that revenues can be sunk back into growing the resource.” (See also

Hermes Eos is a subsidiary of Hermes, the fund manager owned by BTPS. It offers responsible investment and corporate governance advisory services to asset owners and managers, helping them manage their assets as long-term, engaged investors.

Most exponents of responsible investment attempt to filter their investments or choose stocks on the basis of environmental, social or governance grounds, and claim to offer either an easy conscience or relative outperformance, or both.

Since its primary client, BTPS, as well as most of the other pension funds using its services, is so large it is effectively a universal owner, unwilling to take major sectoral or stock specific bets, Eos attempts to use engagement with companies to improve their stock performance.

Although most of its clients face a more conventional fee structure, BTPS has committed to paying a performance fee for improvement in returns it can attribute directly to Eos’s services, a fee it has had to pay for the past three years.

The problem with this business model appears to be the danger of free riders. If Eos’s engagement has a positive impact on share prices, any investor with an index tracking portfolio will benefit equally with Eos’s clients. Mr Melvin thinks the benefits of joining are sufficient to outweigh the free rider option.

Every pension fund that joins improves the outcome, as the more assets Eos represents, the more weight it carries when talking to investee companies. “We have a resource here that no one pension fund could run on its own,” he points out.

In September 2008, Eos represented about £50bn, although that amount has fallen with the markets, and employs 25 people full time.

Among its 11 clients, Eos counts nine pension funds and just two asset managers (Nordea and Investec Asset Management). Mr Melvin thinks this indicates who has the most incentive to engage in responsible ownership in the current structure of the investment industry.

Fund managers may be reluctant to challenge company management, he suggests, because they are reliant on those same managers for information about the company’s activities.

While asset managers have been sacking corporate governance and sustainability analysts in recent months, pension funds have been actively approaching Eos to ask about its services, says Mr Melvin. He credits both of these developments to the current stressful economic environment.

“This says a couple of things: first, [of the companies that sacked analysts] they weren’t doing it properly. Second, clients are much clearer on what they’re paying for.”

Whether or not they are paying for improved investment performance (a much debated topic, without a definitive answer from an unbiased source), pension funds may also be paying for a reputational benefit.

“Pension funds are under increasing pressure to be seen as good owners of companies, as well as to be good owners,” says Mr Melvin.

In Northern Europe in particular, he says, there is media pressure for pension schemes to act as responsible owners. “In the current environment, for clients to decide they don’t want to be responsible investors wouldn’t look too good, would it?”

Mr Melvin is adamant, however, that Eos is not merely a fig leaf for investor respectability. In fact, he is prepared to claim that if it had had critical mass, it could have helped mitigate, if not avert, the credit crunch. “Investment banks all focused on trading activity over risk management; they all had incentive structures that promoted short-term behaviour; more broadly, they innovated when they should have behaved like utilities.”

Eos picked up on these issues and spoke to the erring financial institutions but with a mere £50bn in assets behind it, could not get a hearing.

Mr Melvin hopes the future may be different.

“This time we’ve paid for it with a triple whammy: as taxpayers, as investors and as participants in the real economy. If we work together, we can get a stable system. Otherwise we run the risk of seeding the next bubble with government money.”




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