Hermes, the pensions management firm, wholly-owned by the BT pension scheme, is living up to its moniker with the unveiling of its new corporate governance charter – ‘The Hermes Principles’, which it believes could send an important message to institutional shareholders about how they invest in companies.
The 10 principles, laying down what the investment manager believes should be the expectations of investors as owners of companies, will be rolled out across the fund manager’s entire £40bn (E64bn) portfolio – mirroring the firm’s Focus fund range, which seeks to add value in companies through governance improvements.
The document, to be sent to the boards of all UK listed companies, claims that over time there have been failings on both sides that have created a lack of trust between investors and corporations.
David Pitt-Watson, managing director of the Hermes UK Focus Fund: “Previously there was always an implicit assumption that companies would deliver shareholder value, but things have not always gone that way.
“The ultimate goal of a company is to create wealth for its shareholders. This in turn suggests a number of actions that it is reasonable for shareholders to expect.”
Pitt-Watson believes that Hermes’ unique position as a large fund manager directly owned by a pension fund, puts it in a position to reiterate the long-term investment goals of its main investors – pension funds.
He adds that the presence on the Hermes team of a significant number of former commercial managers also provides an understanding of how corporations work, thus placing the accent on engagement rather than confrontation and ensuring that shareholder involvement is not detrimental to the company.
While the Hermes report accompanying the principles is not critical of the often intense, short-term trading activity that appears to preoccupy modern companies, it argues firmly that this should not dominate discussions with shareholders.
“The best companies have direct dialogue with their investors, who have a longer-term priority. However, too many companies today focus on investor relations with brokers and analysts rather than on those actually investing.”
Pitt-Watson is also clear that the principles do not represent a ‘tick-list’ for investment in companies: “The principles are an articulation of what we are looking for in good companies, but they are open to discussion and we’d like to know if people think we are wrong.
“However, if companies are not taking some of the principles here seriously then there is a likelihood that they might not be taking a lot of other issues seriously.”
In terms of governance itself, Hermes suggests there are a number of management disciplines that will greatly increase the likelihood of value delivery for investors.
One vital communication point, the firm says, is the company’s annual report and accounts.
“These should be an ‘accurate’ report of financial performance and strategy through the year,” says Pitt-Watson.
“If the annual report becomes akin to a glossy marketing exercise then it is hardly surprising that investors stop taking those things seriously. Too few annual reports give clear and frank information.”
On the financial front, Hermes flags up one particularly important notion that it believes has become a victim of opaque reporting – that of weighted average cost of capital (WACC) in decision-making. “Financial reporting disciplines do not often accurately measure or report the cash returns from any investment and hence whether WACC is being achieved.”
A further financial check for long-term shareholder value, the fund manager notes, is whether businesses are seeking to grow through realistic projects that compliment their core competitive advantages, as opposed to seeking unrelated diversification - particularly through acquisitions.
Another potential bone of contention flagged up by Hermes is the prickly area of executive incentives, which the firm states should be based on principled growth objectives.
Rewards structures that can reward executives even in the event of failure, says Hermes, can be detrimental to shareholder value: “Many top management incentive schemes are highly geared through options; some pay out for performance which is indifferent when measured on a relative scale, hence they can reward failure and success.”
Under the heading of strategy, Hermes notes that a shareholder driven approach demands that company goals and the methods of reaching them are properly weighed up after consideration of market dynamics and the potential competitive advantage of the corporation. To this end, Hermes signals the ‘best parent’ scenario as a major checkpoint, whereby companies should indicate a sound business rationale as to why they are the owners of any particular subsidiaries.
Completing the principles are two significant pointers on ‘ethical’ investment; not least the assertion that Hermes believes companies should not seek financial gain at the expense of wider civil society.
Hermes says it sees no profit to its end beneficiaries - its pension fund holders - in companies that pass on costs through unethical behaviour to other companies or the taxpayer. The goal for companies, says the fund manager, should be growth within an “economically, ethically, socially responsible and sustainable framework”.
Says Pitt-Watson: “The last two principles are important, because if you fall foul of them they may be devastating in the short term to the business. A company can be destroyed by losing licences or customer bases, so ethics is a question of business survival as well.”
Hermes argues that the charter should be a boon for companies able to go to shareholders with a specific agenda for protecting the long-term value of the company.
Pitt-Watson also believes the principles may also sit well with other asset managers directed to carry out their ownership responsibilities by the Myners report.
The main goal, however, is to improve a dialogue that has become somewhat muted in recent years, as Pitt-Watson concludes: “Responsible behaviour by boards requires responsible investors and we are taking a significant step in this direction.”

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