Catherine Howarth and Christine Berry write: There’s a fundamental inconsistency at the heart of the UK corporate governance framework. Company directors’ duties under the Companies Act are based on the concept of ‘enlightened shareholder value’: the UK government rejected stakeholder rights or prescriptive regulation and chose instead to encourage companies to take the high road, rather than the low road, to creating value for their shareholders. But, as argued in the FairPensions recently-published report, ‘Protecting our Best Interests: Rediscovering Fiduciary Obligation’ [Click Here], there’s a crucial mismatch between Companies Act policy and the perception many shareholders have that their fiduciary duties actively prohibit an enlightened investment approach.
It’s often implied that fiduciary duty begins and ends with maximising return. That is simply inaccurate. In fact, investors have a number of distinct fiduciary duties, developed over centuries of primarily judge-made law. The most fundamental of these is not the frequently-invoked ‘duty to maximise return’ (assuming such a duty even exists) but the duty of loyalty: agents must act impartially in the best interests of all their principals, and must not abuse their position for personal gain.
In any discussion of fiduciary obligation, it’s crucial to keep this fundamental principle in mind. A key question must always be: is the status quo in the beneficiaries’ interests, including those to whom obligations are owed 50 – 60 years into the future?
Trustees are often paralysed from exercising their judgment on this central question by simplistic legal advice. Instead of ‘is this in beneficiaries’ interests?’ the question becomes ‘is this what everyone else is doing?’ – with the implication that if it isn’t, you could be sued. Thus, fiduciary duty is reduced not just to a duty to maximise returns, but to a duty to maximise short-term returns judged against a market-relative benchmark, and to do so by following the herd.
Ironically, this dynamic may actually work against beneficiaries’ best interests in the long run. The typical fiduciary investor is no longer a private family trust but a multi-billion pound pension fund. Collectively, such investors exert significant influence on the global economy. If prevailing interpretations of fiduciary duty exacerbate natural ‘waves of optimism and pessimism’ in the markets, something is badly wrong. As NSFM participant Keith Johnson says, it’s like unleashing “a herd of 900-pound lemmings into the economy”.
Moreover, if fiduciary investors focus on chasing short-term alpha, there’s a danger that much more important determinants of long-term return will be neglected. Evidence suggests that most variation in pension funds’ returns is down to asset allocation and the resulting beta exposure. Perhaps even more fundamental are the challenges of systemic risk: issues which can bring down whole markets or even the global financial system. For example, more and more investors are waking up to climate change, a defining systemic risk of our times. But the way we think about fiduciary duty still doesn’t provide the tools to act on this realisation.
In order to develop these tools, trustees must be freed from restrictive interpretations of fiduciary duty and empowered to take a rounded view of beneficiaries’ best interests, over both the short- and long-term. This is exactly the ‘enlightened’ approach embedded in the Companies Act.