Perspectives 29 An <strong>Investment</strong> Management Perspective (Mehdi Mahmud) 33 <strong>Responsible</strong> <strong>Investment</strong> and Sell-side Analysis (Francis Condon) 41 <strong>Responsible</strong> <strong>Investment</strong> and Pension Funds (Stephen Davis) 28
An <strong>Investment</strong> Management Perspective Mehdi Mahmud, Executive Vice-President, Jennison Associates Overview <strong>Investment</strong> management is one of the most highly regulated industries in the world. Critics argue that this has led to a gradual diminution in creative, long-term oriented (and potentially more rewarding) approaches to investing. On the other hand, proponents point to recurring instances of the industry’s failure to police itself as the driver of increased regulatory scrutiny. Regardless of which camp one might sympathize with, the net effect is that the investment management business, in the United States and the United Kingdom in particular, has evolved into a carefully calibrated system of checks and balances designed to value “investment process” and “control” as much as “superior returns” and “risk.” Stated differently, the net impact of these checks and balances is that significantly more emphasis is now placed on producing proof statements of control and measurement at each stage of the investment process than ever before. This occurred in conjunction with developments in the vernacular of portfolio and performance analysis, which has rapidly become the standard for investment communication among constituents in the fund management industry. Key participants in this equation, on a daily basis, include beneficiaries, trustees and their investment committees, financial advisors and consultants, fund managers, third party research providers (commonly sell–side firms), and of course, the universe of publicly traded companies in which fund managers may invest. Regulators play an omnipresent, though more strategic, role in directing the method and content of interaction among participants. This image — of an industry that has developed around an elaborate system of checks and balances — is critical to keep in perspective during any serious examination of the methods by which the industry’s practices might evolve over time. From the point of view of the investment manager, perhaps the simplest visualization of how the key participants interact with each other is to imagine five rings, arranged in a horizontal line, connected by a string. The leftmost ring represents the client, including beneficiaries, trustees and their investment committees. The centre ring represents the fund manager, and the rightmost ring represents the universe of companies in which the fund manager may invest. The ring that separates the client from the fund manager is the investment consultant to the client, while the ring that separates the universe of publicly traded companies from the fund manager is the sellside analyst (broadly defined to include investment bankers, market makers and third-party research vendors). Assuming that information is ubiquitous, it is nevertheless a useful (though approximate) construct to imagine the string as the primary pipeline for information exchange and formal interaction among the various participants. The role of investment consultants in the clients’ decisionmaking processes cannot be overemphasized. Consultants provide a wide range of services to clients, notably: advice on benefits policies, asset allocation analysis, selection of benchmarks, due diligence on fund managers, and recommendations on manager selection, evaluation, and termination. Although plan sponsors retain responsibility as primary (named) fiduciaries, consultants provide much of the analysis and tools by which investment committees and trustees make decisions. As a result, the lens through which consultants and plan sponsors view the fund management industry — composed of the metrics and language by which they evaluate fund managers — is a critical determinant of behaviour in the long-term. Their perspectives on the relative attractiveness of various asset classes, their selection of benchmark indices used to measure fund managers’ performance, their assessment of active managers’ ability to outperform passively-managed alternatives, and their investment time horizons have profound impact on fund flows into and within the industry. Consultants are key participants in the value creation chain and, in the context of responsible investing, will likely be important agents for influencing change. The sell-side fulfils a somewhat analogous role with publicly traded companies, through: advice (in the form of investment banking relationships); trading desks (which make markets in their stock); and research departments (that “report” on company news). Notwithstanding the negative press they have received, sell-side research departments fill an important information gap in the fund management industry, providing an efficient means for companies to disseminate information to the marketplace. In particular, following Regulation Full Disclosure (Reg. FD) in the United States, which requires corporations to treat all investors equitably in the dissemination of material information, the sell-side has taken on an even more substantial role in coordinating access to companies’ management teams through conferences and presentations. Given their role as “reporters” of financial information — despite the caveat that there is no implicit or explicit guarantee of objectivity in their content — the sell-side is likely to remain an important participant in the industry as it evolves. 29
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