Who's minding your money? Is your pension managed?

City institutions do little to control the companies they invest our savings in, says Patrick Hosking Institutional investors are failing all of us with pension funds or life policies, says Patrick Hosking Institution al investors fail us all by condoning badly managed companies, says Patrick Hosking
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The Independent Online
AN amazing thing happened in the City a week ago. Hermes, one of the biggest investors among the pension fund managers and life assurance companies which own great tracts of Great Britain plc, announced plans to appoint a "troubleshooter" to force badly managed companies to mend their ways.

Nothing strange in that, you might think. That's their job. Surely these institutional investors - as they are called - who manage hundreds of billions of pounds of our savings and pension contributions are constantly trying to reform or replace greedy, incompetent or complacent managers? They are, after all, the surrogate owners of every British quoted company. They have a duty to the millions of people who put away a few quid each month in a pension or savings plan on the assumption the money is wisely invested in companies run by good managers.

Well, no, actually. These powerful fund managers would do anything rather than exercise their power in the affairs of the companies they control. Most do not bother to vote on company matters. Nor do they attend companies' annual general meetings - the only opportunity to put questions to the full board.

If the gulf between British institutions and the companies they invest in is wide, the gulf between them and their clients - you and me - is wider still.

Anyone putting money in a pension scheme or investing in a life assurance policy or buying a unit trust or personal equity plan has an interest in how their money is invested. Ten million people in Britain have money invested in occupational pension schemes and another 5 million have personal pensions. Millions more have money invested indirectly in the stock market through endowment mortgage policies.

In terms of pension fund membership, Britain is the most advanced country in Europe. The Government has drummed into us that we cannot rely on the state for a comfortable old age so we have built up a pot of pounds 600bn in our pension funds, according to the National Association of Pension Funds - more than the rest of the EU put together. By the time we retire we have roughly the same amount of money in our pension funds as we have in our homes. Yet we devote a fraction of the attention we give to our house purchases to our pension arrangements.

Most people would be hard pressed to name any of their pension fund trustees, let alone the fund management companies entrusted to nurture their nest- eggs. Each year we receive a jargon-filled pension fund annual report - actuarially impeccable, no doubt, but highly indigestible, often incomprehensible and sometimes downright misleading.

Over the lifetime of the pension or life policy, fund managers take out in fees 10, 20 or even 30 per cent of the money put in. It can be up to 100 per cent for life policies cashed in early, as many home buyers with endowment policies have discovered to their horror. We pay thousands of pounds each to these fund managers in fees over our lifetimes. The better-off pay tens of thousands. Yet the institutions come under little scrutiny. Even the Maxwell scandal hasn't made much difference.

Aren't we entitled to expect that at the very least the people investing our money exercise some control over badly managed companies?

The traditional sanction for a shareholder is to sell the shares. It's a passive non-confrontational approach. And it allows bad managements to survive unreformed, unpunished and drawing large salaries, sometimes for years.

Bad management is still rampant in British companies. There is a view - nurtured by managers - that the quality of British management has dramatically improved in the last 15 years. In some ways it has: waste and bureaucracy have been weeded out; power and responsibility have been devolved; stock control and distribution systems are more efficient; and workforces are more aware of the importance of product quality.

But in other ways senior managers are worse. They are greedier, paying themselves much more and devoting more of their time to how they pay themselves much more. They are repeatedly seduced by the siren voices of the merchant banks, who urge them one year to make acquisitions, then the next year - the latest corporate panacea - to demerge. They can become obsessed with slicing away at costs, even when all the fat is gone and further cuts patently damage the business. And they are useless at coming up with new ideas and seeing them through from drawing board to finished product or service: it's always much easier to buy up someone else's company instead.

Even the passive sanction of selling the shares of badly managed companies is becoming less of an option for our largest investment institutions. Billions and billions of pounds each year are now put into "index tracking funds" - vehicles designed to shadow the stock market index. There is no attempt to pick winners. Institutions buy the shares whether they like the company or not. The holdings of some of these funds get so big they cannot sell out of a company without triggering a significant fall in the price and therefore a reduction in the proceeds they could expect from the sale. They become locked in.

But they do have enormous power. Prudential Corporation, for example, owns an average of 3 per cent in every quoted company. Hermes, the institution creating the troubleshooter post, has pounds 30bn invested on behalf of the 750,000 members of the Post Office and British Telecom pension funds. These big investors - as distinct from small private shareholders - now own around 70 per cent of the stock market. One-third of the shares in the average quoted company are in the hands of 25 big institutions.

But these same major shareholders are feeble in exercising that power. They have the available muscle of a herd of charging buffalo, but the energy and direction of a herd of browsing cudsters.

Occasionally we get a glimpse of this muscle. Take executive greed. Until three years ago it was the norm for senior executives in large companies to be awarded three-year or even five-year rolling contracts. There was no justification of any sort for these arrangements; they merely ensured that executives who weren't up to the job took away with them severance pay of three (or five) times their salaries.

Today the three-year roller has disappeared. Its disappearance was largely down to one man, Alistair Ross Goobey, chief executive of Hermes, who wrote to company chairmen warning them that Hermes would vote against the re-election of directors on three-year rollers. The threat was enough.

Take overweening ambition. Farnell Electronics, a large, fast-growing computer parts distributor, decided last month to buy the American firm Premier for pounds 1.8bn. Some institutional shareholders, including Legal & General and Standard Life, reckoned the deal was too risky and too pricey. Premier was twice Farnell's size. It would have to take on huge debts to afford it. The history of corporate acquisitions is littered with hubristic UK companies which have crippled themselves in North America (Ferranti, Ratners, Dixons). In the end Farnell got the deal through, but at least the public revolt provoked a serious debate about the merits of an acquisition which otherwise would have been nodded through.

The Farnell episode may come to be seen as a turning point for institutional investors. At last a few are prepared to speak out against what they see as bad management.

But the majority remain timid, and there is a good reason why. Pension fund managers are always on the look-out for new pension funds to manage. The decision on who manages a company pension fund rests with the company. Fund managers are terrified of offending any company in case it might jeopardise their chances of winning the contract.

So managements have to be doing an appalling job before institutions call for heads to roll. Even at the height of the British Gas shambles last year, institutional investors supported the chief executive Cedric Brown and the rest of the board. At Saatchi & Saatchi it was only the intervention of a US fund manager - a more aggressive species altogether compared to their UK counterparts - that saw the eventual ousting last year of Maurice and Charles Saatchi who had brought the advertising agency group to its knees.

We have the right to expect more. At the very least that the people investing our money should be prepared to discuss their decisions. Communication between the ultimate owners of companies and company management is pitiful. It is a tale of ignorance, apathy and self-interest. Company managers need to be more accountable to institutions; institutions need to be more accountable to their customers - the people contributing to pension funds and life policies.

The anonymous institutions need to realise they are our servants, investing our money.