The Kay report is a cracking read. I would recommend Chapter 1 to anyone - as cogent an account of UK corporate failures (and successes) over the last 30 years that you will find anywhere.
It certainly left me contemplating the folly that can be wrought by a combination of ego and of transaction-driven advice.
Likewise, the centrepiece of the report is a series of good practice statements for asset managers, asset holders and company directors which encapsulate well their respective roles and responsibilities. There is a lot of good sense here.
But I do have some issues, most notably the impact of transaction-driven intermediaries. The report rightly draws attention to the number of intermediaries in the investment chain, all of whom take a slice of the investor's return. But the incentives for intermediaries which are rewarded transaction-by-transaction are fundamentally different from those which operate on an agency basis.
What do I mean by this? If I pay you a fee every time I buy something, your incentive is to persuade me to buy as many things as I can, and at a high a price as possible. If, on the other hand, I pay you a retainer to advise me on what to buy, and whether I should, your incentive is to keep the relationship with me for as long as possible, and to do so by giving me the best advice.
We see this today in the retail investment market. In the old days, many advisers were paid sales commissions which gave them the incentive to churn their clients' portfolios even if this was not good for returns. But today the norm among good IFAs - the great majority - is to be paid an agreed fee or a recurrent trail commission based on the value of the portfolio. The incentive for them is to satisfy the client so as to retain the business. This is much more benign from the client's point of view.
Likewise, in the capital markets there are different business models and incentives. For example, market makers sell to and buy from clients and have an incentive to take as big a slice as possible from the trades. Investment banks advising companies have an incentive to maximise corporate transactions because they are generally only paid if the deals are completed. But asset managers operate on a different basis: they are paid a percentage of the value of the assets they manage. This firmly aligns their interests with those of their clients.
There is an interesting paragraph in the Kay report which makes this distinction. Paragraph 4.13 talks about the "important misalignment" of incentives which arises from what the report calls the "bias towards action". It lists a series of parties subject to this, including corporate executives, market makers and analysts. Tellingly, asset managers are not on that list.
So I find it puzzling that the report focuses on the asset management industry - particularly given the initial diagnosis of poor merger strategy leading to corporate failure. True, investors can vote down a transaction. But that is the nuclear option, and the insider dealing rules mean that they cannot receive details about a transaction before the rest of the market. The choice may thus be between accepting a fait accompli or risking a public argument that does more harm than good to the investment. It is surely better to address the root causes of the problem rather than relying on post hoc policing by investors.
Overall, therefore, a thought-provoking report. But I for one would have liked to see a little more focus on the role of investment banks.
Richard Saunders
Chief Executive, IMA
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