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'No Silver Bullet' to End City Myopia

Bold plans to sweep away a culture of short-termism in the City, which has been blamed for undermining company performance and reducing investor returns, will prove difficult to enact, some company bosses and asset managers warned.

They fear recommendations in a 40,000-word year-long review by John Kay, the leading economist, unveiled on Monday, are unrealistic because of the pressure on companies and investors to make short-term profitsand outperform rivals.

Vince Cable, business secretary who commissioned Professor Kay to carry out the review, said: “This is an insightful and powerful review which describes vividly flaws of the UK’s financial markets and their relationships with investors and businesses.”

Chuka Umunna, shadow business secretary, also backed calls in the report to reduce the number of financial intermediaries between savers and companies and applauded moves in the report to tackle excessive remuneration in the sector.

But many of the 17 recommendations, which include calls to improve relationships between companies and investors and the scrapping of mandatory quarterly management statements, will be difficult to carry through, say some industry and market participants.

Michael McKersie, head of capital markets at the Association of British Insurers, said: “It is an extremely well written report and we would agree with the views. Some, however, may prove challenging to implement in practice.”

Matthew Fell, director for competitive markets at the Confederation of British Industry, said: “The overall desire to tackle short-termism and trying to get investors and companies off that short-term carousel is a good thing. These are broadly sensible measures, but there is no silver bullet that will deal with short-termism.”

Many of the recommendations, such as developing good stewardship and long-term decision-making and creating an investors’ forum to facilitate collective engagement, is best dealt with by the industry, say government officials.

Others, such as calls for asset managers to make full disclosure of all costs, including transaction costs, and performance fees charged to funds, would most likely be carried out voluntarily, they added.

Just a few of the recommendations are expected to be enshrined in legislation. These include the removal of obligations for mandatory quarterly interim management statements, which has won approval from some businesses and investors because of the burdens in time and costs this puts on companies.

Tim Ward, chief executive of the Quoted Company Alliance, said on behalf of small companies: “The European Commission through the transparency directive is proposing to do away with interim management statements and we support that. We welcome anything to move us away from the short-term approach.”

Among the leading asset managers, Martin Gilbert, chief executive of Aberdeen Asset Management, one of the biggest in the UK with 182.7 billion pounds ($283.5 billion) in assets under management, said he was “very supportive of John Kay’s findings”.

“As an asset manager, we have very low turnover of about 10 percent annually because we believe it is best to buy a good company and hold on to it as long as we can,” he said.

“By being a long-term investor, it helps with engagement and corporate governance. We can engage with companies and act as proper and responsible owners of their stock.”

However, it was Prof Kay who best captured the difficulty of bringing about a change of culture in financial markets.

“Short-termism, or myopic behavior, is the natural human tendency to make decisions in search of immediate gratification at the expense of future returns, decisions which we subsequently regret,” he wrote. “We speak and act in the heat of the moment, we eat and drink too much, and we do not save enough.”

For many companies and investors, the pressure to make profits and produce investor returns forces them to act in a short-term way. “We have a high churn rate of stocks,” says one equity portfolio manager at a top UK fund manager. “This is because our clients demand it. They want us to constantly seek better companies and better returns. It will be difficult to change that mindset.”

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The long view: The main recommendations from the report

Look further ahead: Change culture of investing

Professor Kay calls for a radical shift in the culture of investing, arguing that companies and investors should develop a longer-term view, writes David Oakley. Companies should stop trying to manage short-term earnings expectations, while investors should seek to hold stock for much longer periods. Many asset managers hold stock for only up to six months, which means they have little opportunity to engage with the company to help develop strategy and company performance. However, other asset managers do put an emphasis on holding stocks for much longer periods. Some portfolio managers agree that, in an ideal world, they would hold a stock for ever.

Fewer links in the chain: Reduce the middle men

Mandatory interim management statements every quarter should be removed as an obligation for listed companies, as this leads to short-term corporate and investment decision-making because of the pressure to produce results that are better or outperform peers. It is also time-consuming for companies to produce these reports – time that could be used more fruitfully to develop longer-term strategies, the report says. Some chief executives say it is a burden that they would like to be relieved of, while investors often complain that the statements do not add much to the sum of knowledge on the company’s performance.

End quarterly reports: Use time more fruitfully

Professor Kay argues that equity markets need a sharp reduction in the number of intermediaries between the average retail investor and the company whose stock they finally buy, as the chain of go-betweens in the investment process has grown far too complex and costly. It is not unusual for an independent financial adviser, an investment consultant, a pension fund trustee and then finally an asset manager all to be involved in making decisions on picking stocks. Professor Kay would like a return to more simpler times when fewer people – who all have to be paid fees – were involved in the process.

Concentrate portfolios: Engage more effectively

Investors should increase the concentration of their portfolios so that they hold fewer stocks. This would enable them to engage more effectively with companies. Increasingly, investors are diversifying to protect themselves against risk. But this means holding hundreds of stocks all over the globe, making it impossible to engage with boards or executives of all the companies they have a stake in. Professor Kay says more concentrated portfolios would mean fund managers could play a more active role in developing strategy and acting as a check on poor policy decisions on key matters such as remuneration.

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