Richard Saunders, CEO of the Investment Management Association, the UK buy-side industry body, has warned that the concept of “short-termism” needs to be better defined if a review of the UK stock markets is to tackle behaviour that genuinely harms long-term investors.
“There has been a lot of nonsense spoken about short-termism and the degree to which the review can dispel that will be welcome,” said Saunders.
On 22 June, the UK's secretary of state for business, innovation and skills, Vince Cable, announced that an independent review of the UK's equity market, led by Professor John Kay of The London Business School, would examine investment in UK equity markets and its impact on the long-term performance and governance of UK-quoted companies.
Cable said a call for evidence last October had raised concerns about the impact of short-term executive performance targets and the growth of short-term equity trading strategies. The review is tasked with strengthening engagement between institutional investors and quoted companies, ensuring that the timescales over which companies and fund managers operate match the interests of investors and analysing the implications of fragmented share ownership in the UK.
Saunders said some accusations of short-termism against financial markets were “a little vague”, but identified two legitimate areas of investigation: the effect of the activities of short-term traders and intermediaries on the end-investor, and the impact of short-termism on investment decisions.
“High-frequency trading (HFT) has no economic value,” he asserted. “It's increasing liquidity but frankly liquidity was already at a sufficiently high level so all it's doing is extracting money from the market… the extent to which that is coming from shareholder value is unfortunate.”
Saunders added that HFT had the capacity to hurt the long-tem investor by increasing frictional costs for accessing liquidity. “If ”rent extraction' can be kept to a minimum, that is good for end-investors,” he added. “But I have grave doubts as to whether HFT has any effect on which companies are bought and sold.”
He added that asset managers were pressurised into taking a short-term approach to investment by competitive forces, particularly the need to demonstrate performance to end-clients on a quarterly basis. “The client has a consultant sitting next to them who the asset manager worries may fire them due to a short-term dip in performance; that is the extent to which they worry about short-term pressures,” Saunders said.
Pension funds are typically advised by consultants that identify selection criteria and organise ”beauty parades' of asset management firms before end-investors award mandates.
Increased frequency of reporting doesn't just deliver a shorter-term view of potential rewards, said Anthony Kirby, head of regulatory reform for asset management at consultancy Ernst and Young, who argued that it can also exert a positive pressure.
“There is a growing tendency for buy-side firms to monitor and adjust their risk appetite on a dynamic rather than an annual basis,” he said. “If they are refreshing their liquidity risk scenarios each quarter rather than once a year that is positive.”
A panel of experts is to be appointed to work with Kay, who will produce a report in 2012.