12th DEVELOPMENT DIALOGUE 2014: RETHINKING DEMOCRACY
INTERNATIONAL INSTITUTE OF SOCIAL STUDIES
ERASMUS UNIVERSITY ROTTERDAM, THE NETHERLANDS
16-17 OCTOBER 2014
INVESTOR GOVERNANCE REVISITED:
THE RISK AND REWARD OF DEMOCRACY IN INSITUTIONAL
FINAL DRAFT: 30 AUGUST 2014
COLIN V. HABBERTON
UNIVERSITY OF STELLENBOSCH BUSINESS SCHOOL
Mobile: 071 401 2434 / Office: 021 801 8182 / Fax: 086 540 5659
Physical: Mera Ghur, 22 Raapenberg Road, Little Mowbray, Cape Town, 7700
Postal: Suite 90, Private Bag X9190, Cape Town, 8000
A common assumption is that institutional investor decision-making is driven by skilled
financial professionals focussed on the maximisation of financial return, without
providing individual contributors the opportunity to participate in the decision-making
This paper investigates whether institutional investors, the dominant agents in investment
markets, adequately take into account the interests and opinions of individual capital
contributors who are a significant source of the ongoing flow of capital into investment
markets. The argument is presented through the lens of governance exploring whether
democratic principles such as participation, transparency and accountability might offer
individual investors a greater opportunity to exercise their choices and individual
interests through their investment behaviour.
Empirical evidence was derived from semi-structured interviews from institutional expert
investor representatives. Findings show that institutional investment decision-making is
indeed concentrated amongst a set of highly skilled and experienced financial specialist
individuals and organisations. These agents operate on a common understanding of their
fiduciary duty – to maximise investor returns relative to analysed risks. In addition,
individual contributor participation in the investment decision-making process appeared
to be limited, even when choices on investment options and results are communicated to
Due to the complex nature of investment decisions, the institutional investor participants
felt that there are a host of risks associated with introducing elements of democracy into
investment decision-making. Collectively these risks may prove challenging to consider,
even chaotic, and they therefore question the viability of such an approach.
Despite these reservations, participants acknowledged that expanding the scope of
investor governance offered potential rewards. Increased investor participation would
most likely hold institutional investors responsible for recognising the interests of
individual contributors as stakeholders of the investment system. Furthermore, there
appeared to be consensus that greater access to information and education of individual
investors might hold institutional investors more accountable for their investment
decisions and in particular the responsibilities of asset ownership.
In reflection of the increase in global inequality, the dominant influence of global
financial markets and the prevalence of scandals in the financial industry, the education
and participation of individual investors in investment decision-making potentially
presents an untapped transformational influence to shape the flows and impact of capital.
1. INTRODUCTION AND RESEARCH QUESTION
“If liberty and equality, as is thought by some are chiefly to be found in democracy, they
will be best attained when all persons alike share in the government to the utmost.”
Despite 20 years of democracy, South Africa holds the infamy of having one of the
highest levels of income and wealth inequality of all countries in the world (World Bank,
2014). South Africa’s close companion is the United States of America (USA) that
currently has the highest inequality of all developed nations (Stieglitz, 2013:29). Piketty’s
(2014:435) research into the wealth and income distribution of 12 countries and over 200
years of data, demonstrates that global inequality is progressively increasing as the rate of
return for the owners of capital exceeds the rate of growth in income and wages. In short,
‘the rich are getting richer and the poor are getting poorer’ is as true today as ever before.
Key instruments that enable the return on capital in financial markets include equities,
bonds, commodities and currencies traded within and across nations. In terms of financial
market activity, institutional investors 1 dominate investment flows globally. They
account for the majority of ownership of companies in the US (Aguilar, 2013; Blume &
Keim, 2012:7), significant segments in OECD countries (OECD, 2014) and South Africa
(ASISA, 2014a). Due to their concentration of ownership, institutional investors have the
right and power to influence decision-making in the companies in which they are
invested as shareholders either as owners, or as agents mandated to act on behalf of their
clients. Consequently, the decisions they make regarding their assets under management
(AuM) significantly impact the economies and communities connected to those assets.
Institutional investor decision-making is ordinarily driven by the objective of the
maximisation of financial return for their clients’ investments (Graham, Zweig & Buffett,
2003; Bodie, Kane & Marcus, 2008:682). In the context of the global impact of the recent
Libor2 and currency fixing scandals3, the process of how and why investment decisions
are made demands attention. In South Africa, the Marikana tragedy of August 2012
highlights the economic and social consequences of investor commitment to profit at the
expense of the interests of people. Investment decisions appear to be made by the few
with the funds provided by the many, impacting us all. Consequently, greater focus is
required on topics of investors’ transparency and accountability to the broader base of the
shareholders they are there to serve, and the stakeholders they really do impact.
1 Institutional investors typically include “retirement funds, long term insurers and collective investment
scheme management companies”. (SARB, 2014a).
2 The London Interbank Offer Rate (‘Libor’) scandal discovered in 2012, refers to the manipulation of
interest rates by traders from at least 20 of the world’s biggest banks. Libor is estimated to affect the price of
more than US$ 800 trillion worth of global financial instruments, equivalent to four times the world’s Gross
Domestic Product at that time. Those instruments range from complex derivatives to mortgages and credit
cards (The rotten heart of finance, 2012).
3 In February 2014, the UK’s Financial Conduct Authority launched investigations into top banks fixing the
rates of key currencies in foreign exchange trading. With this market turning over GBP3 billion per day, it is
compared to the Libor scandal that up to 2014 resulted in banks paying over USD$ 6 billion in fines (Foreign
exchange allegations 'as bad as Libor', says regulator, 2014).
One lens that provides an insightful perspective on this challenge is the consideration of
governance and how it promotes democratic characteristics (such as transparency,
participation and freedom of choice) in the investment decision-making processes of
institutional investors. South Africa’s robust corporate governance framework demands
executive decision-makers to think and act beyond an assessment of the interests of
shareholders to include the interests of all stakeholders affected by the operations and
decisions by a business. Is good governance applied and practiced in the same way by the
institutions and their appointees taking responsibility for investment decisions on behalf
of stakeholder communities, such as individual contributors to pension funds, retirements
funds and collective investment schemes?
2. Research methodology
The analysis of the existing regulatory and normative frameworks influencing
institutional investors decision-making models forms the theoretical foundation of the
paper. Secondary literature research refined the conceptual framework to inform the
selection of population, sample frame and appropriate individuals to approach for
interviews. The consequent understanding of the theory, industry and experts was
integrated into the design of semi-structured interview schedules.
The interviews consisted of a series of closed and open-ended questions based on the
literature reviewed. Particular reference was made to the alignment with existing
normative frameworks of principles to guide the investment industry towards more
transparency and accountability including the Code for Responsible Investing in South
Africa (CRISA) principles and the PRI. Potential interviewees were approached by
invitation. A key determinant for respondent selection was for each individual to be
willing, appropriately experienced, knowledgeable, and a participant in the investment
decision-making process within his or her institution. The size of assets under
management (AuM) was not a criterion for selection, but it as an indicator of industry
influence and is therefore a relevant factor for the comparative analysis of perspective.
The gathering of primary data for this paper was undertaken in August 2014. The
population and sample frame identified for the research was guided by the list of South
African signatories to the United Nations’ Principles for Responsible Investment
initiative (PRI). Signatories were categorised as ‘asset owners’, ‘asset managers’ or
‘professional services providers’ (UNPRI, 2014b). Expert, senior representatives from
South African investment institutions were invited to participate in the research. Subjects
were selected in reference to the PRI categorisation and signatory status. Interviews with
executives of two key industry stakeholders in the SA financial industry discussed in this
paper – ASISA and IODSA – were also included in the sample. To avoid response bias,
non-PRI signatories were also included in the sample from each PRI category. In total,
nine representatives accepted invitations to participate in the study. While interview
candidates were selected and confirmed, questionnaires and interview schedules for the
respondents were designed and tested by the researcher’s promoters to ensure quality,
relevance and reliability. The researcher informed all respondents of the purpose of the
research and received signed consent for participation in the study.
Interviews were allowed to withdraw from the study at any time without any
consequences. Pseudonyms, where requested or deemed appropriate, were used to ensure
the anonymity of the research participants. The summary of the features of the research
sample, categorisation and scheduling is detailed in Table 1.
. Table 1: Summary of Interview Respondents
*Information derived from each interview and/or corporate websites
The objective of the research was to investigate the effectiveness of current normative
and regulatory frameworks to guide asset owners and asset managers in their decision-
making in alignment with the emergent paradigm of ‘responsible investing’ (RI). As a
component of the research process, the industry professionals that participated were
probed to assess how and why investment decisions are taken. Furthermore, methods of
communicating decisions, including commitments to wider stakeholders were queried to
assess levels of transparency, accountability and participation. Finally, participants were
asked for their personal opinion on potential risks and rewards for collaborative
investment decision-making to investigate the feasibility of a more democratic approach
to investment in line the thematic context of the paper.
3. MESSAGES FROM MARIKANA
3.1 The tragedy and its underlying dynamics
Between the 11th - 16th August 2012, at a platinum mine in the North West province of
South Africa, 44 people died, 70 were injured and 250 arrested, resulting from armed
conflict between miners and security forces from multinational mining company Lonmin
and the South African Police Service precipitated by a strike surrounding wage
negotiations (The Marikana Commission of Enquiry, 2014; Piketty, 2014:39). The
‘Marikana Massacre’ sent shockwaves through the country from an economic, social and
political perspective fuelling further unrest between mine owners and striking miners
through to 2014, spilling over into protracted strike action in other industries across South
Africa as well (Burkhardt & Bhuckory, 2014).
One of the telling images associated with the Marikana tragedy were mineworkers
waving their payslips at the press covering the story, pointing to them as evidence of their
‘take home pay’ to justify their dispute (Some hidden facts behind Marikana mine strike,
2012). On closer investigation however, the wage gap between what workers were paid
compared to the mine executives was only one aspect of a complex problem. Journalists
discovered that cash loan businesses in the Marikana area were willing to offer loans up
to 50 per cent of a miner’s net salary with servicing costs up to 25 per cent per month
(Steyn, 2012) with repayment and defaults deducted via their company payroll. As
individuals choose the immediacy of access to money, they sign themselves into a debt
trap - a subtle form of bondage that negatively affects their lives, their families and their
future (Microfinance and poverty alleviation in South Africa, 2013).
For the institutional investor however, the investment case, from a distance is attractive.
The reward of generating high returns from customers paying high rates of interest on
loans outweigh the risk of investing in businesses offering unsecured debt to the poor,
illustrated by their collective shareholding in unsecured lending businesses, one example
being African Bank (Barry, 2014).
3.2 Investor impact
The 2014 platinum belt strike resulted in short term gains with a nominal increase in
mineworker wages and celebration for the union that fought for it. For the near-term
however, it appears that loss of jobs, rating agency downgrades and ongoing strike action
in South Africa are inevitable (Isa, 2014). From an investor perspective, there is deeper
impact - the ripples have now become waves.
In the wake of Marikana, Lonmin’s share price dropped over 60 per cent by the end of
2012 (Gifford, 2013) with little recovery up to July 2014. This loss in material terms of
tens of billions of its market capitalisation affects all its investors, including pension
funds invested in Lonmin shares, who are left asking worrying ethical questions
(McClenaghan, 2013). In August 2014, South Africa’s largest lender of unsecured debt to
consumers, African Bank, saw its share price collapse on the back of poor trading
conditions with Marikana and other mining strikes as contributing factors (Mantshantsha,
2014). The Government Employees Pension Fund (GEPF), South Africa’s largest asset
owner (Crotty, 2013) and African Bank’s largest institutional investor, lost over R1billion
as a result of their exposure to African Bank’s demise (Barry, 2014). African Bank’s
business model was based upon the provision and collection of credit from low wage
earners such as platinum miners, a key contributor to the debt trap for the clients like
those in Marikana. In light of this destruction of shareholder value, are the contributors
into pension funds like the GEPF aware of where their money is invested and what the
extent and reasons were for returns and losses on investments such as African Bank?
Perhaps one way the lives lost at Marikana could be remembered is for the questions the
emerge in trying to understand how it all happened and shed light on the underlying
financial dynamics that led to the tragedy. Coupled with this example, scandals and their
deep consequences litter the financial sector. The mortgage-backed securities collapse
that precipitated the financial crisis in 2008 resulted in global social, economic and
political impact. To date fines have been metered to global financial institutions in excess
of US$100 billion (Braithwaite & Scannell, 2013) with minimal legal consequences to
date for the financiers responsible for the decisions made. Further scandals, including the
fixing of the Libor and foreign exchange rate collusion in 2014 justifies the examination
of the topic of governance and its role in the responsibilities of institutional investors.
4. THE RISE OF RESPONSIBLE INVESTING
4.1 The emergence of institutional investor dominance
Institutional investors, as compared to individual investors, are financial institutions that
invest large volumes of capital into financial instruments either for their own benefit, or
on behalf of other institutions or the aggregated funds of individual investors (Kariithi,
2007:65). Institutional investors are categorised into two main types, defined by their
respective ownership of the assets under their control – asset owners and asset managers.
Asset owners include institutions such as pension funds, provident funds, endowment
funds, life insurance companies, banks, corporations and non-profits that invest their own
funds into various financial instruments. A key objective for investing their capital is to
maximise returns from their capital to generate additional income, capital growth or
hedge risk to meet the future needs of their respective beneficiaries and shareholders
(Bodie et al, 2008:684-687). In most cases asset owners invest and manage their funds
through asset managers factoring in the advice provided by asset consultants. Asset
managers, also referred to as ‘professional’ investors, are service providers who through
mandates provided to them by clients – either institutions or individuals’ pooled funds –
invest that capital into financial instruments, managing the performance of those funds
for a fee. Asset consultants are usually appointed by the trustees of pension funds (asset
owners) to assist with decision-making regarding asset allocation and the selection and
evaluation of investment managers (Clarke, 2000:74).
It is calculated that over 67 per cent of US market capitalisation is under the control of
institutional investors, owning 73 per cent of their 1000 largest companies translating to
US$11.5 trillion in value (Aguilar, 2013; Blume & Keim, 2012:7). The US pattern is not
unique. OECD statistics show an average of just over 40 per cent of total financial assets
under the management and/or ownership of institutional investors for its 33 member
countries (OECD, 2014). In South Africa, institutional investor dominance also prevails
with large parastatal asset owners in addition to private sector institutional investors
currently managing assets that account for more than 50 per cent of collective investment
funds (ASISA, 2014). The largest asset owner, and the single largest investor in the South
African economy, is the GEPF with an estimated R1 trillion in assets. Over half of
inflation linked government bonds and over 10 per cent of all equities listed in South
Africa are owned by the GEPF (Crotty, 2013). A large portion of the GEPF assets are
managed through another parastatal, the Public Investment Corporation (PIC), which has
an estimated R1,6 trillion AuM (Miller, 2014). As the dominance of institutional
investors has increased, normative frameworks to guide institutional investor decision-
making have also emerged. The GEPF and the PIC have played an influential role in the
recognition and adoption of one of these in particular – the PRI.
4.2 The Principles for Responsible Investment
Drafted in 2005 through the collaboration of a multi-national team of financial
institutions and industry experts, the PRI was launched in April 2006 (UNPRI, 2014a).
The PRI seeks to promote the importance of ESG factors in investment practice. Its
principles seek to address the limitations of financial markets to adequately address
socio-economic inequalities, negative environmental impact, corporate governance
failures and systemic risk. Aside from the ethical perspective of such a paradigm, the
rational argument for ‘responsible’ investment is that it enhances the analysis of
investments, risk assessment and potential for medium to long-term returns (UNPRI,
2014b). In effect, the PRI calls institutional investors to include ESG considerations in
their investment decision-making and their market participation. Figure 1, illustrates the
growth in signatories to the PRI and their collective AuM.
Figure 1: Growth of the PRI Initiative
(Source: UNPRI, 2014e)
Up to July 2014, the PRI has grown to over 1 268 signatories, consisting of a global
community of asset owners, asset managers and professional service providers, with
collective assets under management of over US$45 trillion (UNPRI, 2014f). In terms of
compliance, 800 of the total signatories provide currently reports on how they have been
implementing the PRI in their operational and decision-making processes (UNPRI,
2014f). The PRI furthermore claims that 94 per cent of signatories have a responsible
investment policy in place and 71 per cent require reporting on ESG from their
investments. As with all normative frameworks, it is easy to subscribe to principles, but
far more demanding to actually implement principles in influential global organisations
while remaining willing and able to be accountable to them. Nevertheless, the increase in
signatories, submission of reports and pressure created on investments are positive
indicators that institutional investors are showing commitment to the objectives of PRI.
4.3 The PRI in South Africa
South African signatories of the PRI4 include five asset owners, 32 asset managers and
seven professional service providers (UNPRI, 2014g). An analysis of South Africa’s PRI
signatories reveals an interesting anomaly. Four of the five asset owners listed are
government or parastatal entities. There is only one private sector member in this
category – Sanlam. This is surprising considering that the financial market regulator in
South Africa has over 5 800 private sector retirement funds registered with them that
would fit into the PRI’s asset owner category (FSB, 2013:104, SARB, 2014b). In terms
of asset managers, 726 licensees are registered with the FSB with aggregate AuM of over
R 5 trillion of (FSB, 2013: 60), yet only 32 subscribe to the PRI.
These statistics suggest that the PRI is recognised by only a small fraction of institutional
investors in South Africa. On closer analysis, however, participation may not be as
miniscule as the figures above suggest. By South African law, all financial services
providers are required to register with the FSB relative to the product or service offered.
Large institutions that dominate the financial sector report to the FSB and SARB through
a number of different entities and subsidiaries, sometimes in partnership with other
interest groups. These same brands also deliver a range of services in some cases
identified simultaneously through different legal subsidiaries as asset owner, asset
manager, insurer and professional service provider. In addition, asset managers tend to
be responsible for managing the assets of a number of different asset owners, acting as
their agents. Despite a separation when it comes to reporting AuM per fund, they appear
to aggregate amounts under a common brand or asset management entity on their
corporate websites, for example the Old Mutual Group. Further research to trace and
collate the details of the aggregate cross-holdings of institutional investors in South
Africa is required to reveal this to its full extent.
Vitali, Glattfelder and Battiston’s (2011:4) investigation into the network of ownership
control of over 43 000 trans-national corporations (TNCs) concludes that the global
financial marketplace is opaque, and discusses its consequence and implications. The
analysis by Vitali et al. reveals that nearly 40 per cent of the decision-making control of
these 43,000 TNCs is held through a complex web of ownership by a group of only 147
of those corporations. Furthermore, there is an even smaller nucleus of control, where 75
per cent of the ownership of corporations within that group is cross-owned by members
of that same group. Unsurprisingly these are largely made up of financial intermediaries –
4 listed as of July 2014
institutional investors in themselves – that include a variety of global banks, insurance
and investment companies.
This discovery of an interconnected matrix of ownership and control of assets adds
weight to the concerns of the extent of the power of these institutions and the impact that
global financial shocks could induce, damaging competitiveness and market stability.
This revelation offers a plausible explanation to the causality surrounding market failures
and scandals (Vitali et al, 2011:15). While that justifies concerns regarding institutions
that are “too big to fail”, it does not address concerns regarding the responsibility that the
owners and directors of these institutions have considering the substantial power they
wield. The role of corporate governance suggests ways of mitigating investor risk and
reducing the damage caused by the failure of financial markets and the institutions that
operate within them.
5. INVESTOR GOVERNANCE IN SOUTH AFRICA
5.1 The King Report
South Africa is regarded as one of the leading countries on the African continent in terms
of governance (Mo Ibrahim Foundation, 2013). This position can be partly attributed to
South Africa having one of the most recognised and robust corporate governance
frameworks in the world, underpinned by the King Reports on Governance for South
Africa (known as King I, II and III). The normative principles contained in these reports
have developed as business circumstances have changed. King I, published in 1994,
introduced a set of guidelines regarding the appropriate structure and activities for
corporate governance highlighting the separation of role between shareholders, directors
and management. Then King II, released in 2002, added the topic of sustainability.
Released in 2009, King III proposed that directors go beyond an assessment of the
interests of direct shareholders and consider the interests of associated stakeholders
affected (IODSA, 2009:4). King III suggests that a key responsibility of directors is to
direct their company towards sustainable performance in environmental, social and
economic terms. King III specifies three fundamentals– leadership, sustainability and
corporate citizenship (IODSA, 2009:9):
“…characterised by the ethical values of responsibility, accountability, fairness and
transparency…based on the moral duties that find expression in the concept of Ubuntu.”
Furthermore, King III specifically recognises the role of institutional investors, calling for
active ownership in the companies they are invested in, encouraging proxy voting,
engaging management of investments through mandates, ensuring the implementation of
corporate governance, and influencing the application of the governance principles of the
investment industry (IODSA, 2009).
Notably, the Companies Act (No. 71 of 2008) turned a number of the key tenets of King
III into law. Directors of South African businesses are required to implement and
maintain good corporate governance practice under a ‘apply or explain regime’ (IODSA,
2009:6). The consequences for not doing so are substantial, including significant fines
and/or imprisonment (Company Amendment Act 3 of 2011:136). The increasing burden
of governance places a personal responsibility on the shoulders of the directors and most
executive decision-makers of companies in South Africa. It concurrently promotes the
opportunity for shareholders to assume more influence over the decisions and directions
that the companies they are invested in by highlighting the separation of owners between
directors and managers of companies. It is the responsibility of owners to appoint and
oversee directors, holding them accountable for their decisions and actions, as agents in
overseeing their assets. It is the responsibility of directors to appoint and oversee the
management of the organisations under their direction, holding them accountable for the
strategic objectives of owners, leveraging the assets under their management to build
value. In the context of King III, directors now have a further, and arguably more
significant, responsibility to stakeholders in addition to shareholders, such as the
communities and the environment in which the organisation operates.
When it comes to institutional investors operating within and governed by the laws of
South Africa therefore, the owners, directors and management of asset owners, asset
managers and asset consultants are equally responsible. In 2011, the custodian of the
King codes, the IODSA, in partnership with key financial industry stakeholders drafted
the Code for Responsible Investing in South Africa (CRISA) relating specifically to the
activities of institutional investors, directly aligned to the PRI and King III.
5.2 CRISA: The Code for Responsible Investing in South Africa
CRISA applies to asset owners, asset managers, and consultants registered and operating
in South Africa (IODSA, 2011). It is the second code of its kind applicable to
institutional investors in any country (Gordhan, 2011). Detailed in Table 2 the CRISA
principles call for the integration of ESG factors into investment decision-making and
management processes almost identical to PRI, including additional reference to the term
sustainability, consistent to the nomenclature of King III:
Table 2: CRISA Principles
An institutional investor should incorporate sustainability considerations,
including ESG, into its investment analysis and investment activities as part
of the delivery of superior risk-adjusted returns to the ultimate
An institutional investor should demonstrate its acceptance of ownership
responsibilities in its investment arrangements and investment activities.
Where appropriate, institutional investors should consider a collaborative
approach to promote acceptance and implementation of the principles of
CRISA and other codes and standards applicable to institutional investors.
An institutional investor should recognise the circumstances and
relationships that hold a potential for conflicts of interest and should pro-
actively manage these when they occur.
Institutional investors should be transparent about the content of their
policies, how the policies are implemented and how CRISA is applied to
enable stakeholders to make informed assessments.
(Source: IODSA, 2011)
Parallel to the integration of the normative principles of King III into the Companies Act,
the principles of CRISA have also seen integration into the legal and regulatory
framework governing financial institutions in South Africa. In his address at the launch of
CRISA in 2011, the Minister of Finance highlighted that the amendment of Regulation 28
of the Pension Funds Act of 2011 requires pension fund trustees to consider ESG factors
and their impact on long-term investment performance (Gordhan 2011:4; National
Treasury, 2011). In addition to government, other key stakeholders in the South African
financial industry actively support King III and CRISA. The principal financial market in
the country, the Johannesburg Stock Exchange (JSE), also a PRI signatory, mandates all
its listed entities to apply or explain the use of King III in their practice of corporate
governance. In spite of government and institutional support, research into the
compliance of institutional investors with PRI and CRISA does not suggest significant
commitment in practice (IODSA, 2013).
5.3 The implementation and impact of CRISA on the investment industry
In the South African financial sector, research suggests that there has been an increase in
participation and integration of the normative frameworks of King III and CRISA from
2007 to 2013 (Van der Ahee & Schulschenk, 2013:16). However, that appears not to be
the full reality, according to research commissioned in 2013 by the CRISA committee to
assess the extent of institutional investors’ compliance with its principles (IODSA,
2013:5). The report was based on a total sample of 47 responses from representatives of
institutional investors including 20 pension funds, 14 asset managers, four asset
consultants and nine financial groups that are both asset owners and service providers
such as insurance companies and collective investment schemes. Out of the sample, 60
per cent were currently PRI signatories (ibid:11).
Nevertheless, only 40 per cent of the total sample disclosed their investment policies on
proxy voting, inclusion of sustainability factors and identification and mitigation of
conflicts of interest. Less than 10 per cent of asset owners make the detail of the
investment mandates they have in place with asset managers and consultants publicly
available (ibid:6). With regard to engagement practices with their investments, less than
11 per cent disclose their activities or indeed any progress made in relation to disclosure
on CRISA implementation (ibid:7). Of the 30 per cent of asset owners that provide any
form of information relating to CRISA compliance (ibid:8), 90 per cent delegated their
disclosure requirements to asset managers (ibid:9). Alarmingly, no details were found on
how the CRISA principles are applied in their interactions with clients by any of the asset
consultants surveyed (ibid:10). The summary conclusion of the report was that South
African institutional investors exhibit a “passive and selective approach” to the practice
Challenges identified by the report include a need for clarity in terms of definitions and
terms, the need for standardised approaches for reporting and disclosure and
interestingly, “conditions…to allow market forces to encourage self-regulation” (IODSA,
2013:13). Although some influential investors are seemingly taking an active role of
leadership in the space (such as the GEPF and PIC), the IODSA research points to a lack
of consistency in participation and commitment from institutional investors, particularly
from asset owners and asset consultants.
To discuss some possible remedies to such limited participation, compliance and
commitment, a review of the structure of the investing process and its participants offers
a systemic platform to guide recommendations for action.
6. CONNECTING CAPITAL
6.1 Pension funds as a case study of the investment system
Focusing on pension funds registered in South Africa, the governance structure
requirements on individual trustees are clearly specified by the Pension Funds Act and
associated legislation (National Treasury, 2011; Financial Services Laws General
Amendment Act 45 of 2013). According to that legislation, the members of fund – made
up of the beneficiaries and/or contributors of the fund – have the right to appoint at least
half of the trustees to oversee the management of the fund (FSB, 2014c:11).
A board of trustees play a central role in a pension fund’s decision-making. The board
can consist of member-appointed representatives in addition to employer-appointed,
independent and professional trustees (ibid:13). The trustees of each fund are expected to
be the principal decision-makers on how to invest the funds contributed by members.
Decision-making responsibilities for investments however are usually shared or
outsourced by trustees to appointed asset managers and consultants.
The board of trustees sits in the middle of a complex web of relationships of professional
service providers. In practice, trustees have to mediate the needs of the fund and its
beneficiaries, of the interests of its current contributors (either individuals, employers or
both), and of appointing and managing a variety of service providers to administrate the
fund’s operations and its investments. Trustees act as appointed agents of what may well
be competing sets of interests (employees and employers for example), but usually with
one common objective – to maximise the financial return on investments to provide for
the retirement needs of fund members, adjusting for various risks.
Figure 2 is an indicative (rather than exhaustive) illustration of the structure and flows of
value and information between institutions and service providers involved in the
investment management process of a pension fund.
Figure 2: System of the institutional investment process
(Source: Clarke, 2000:73)
By law, the primary responsibility of a trustee is to act in the best interests of the
members of a fund. The fiduciary duty of trustees is substantial with penalties for
dereliction or neglect of duty resulting in being held jointly and severally liable (ibid:19).
Members have channels for recourse through the Pension Funds Adjudicator and
channels of communication to the employer (if applicable) as well as to the Principal
Officer of the fund (appointed by the board of trustees) and/or directly to trustees
Although the maximisation of return is completely understandable, how the decisions are
made and whether the primacy of return maximisation for members is the only
responsibility of trustees of asset owners demands more examination.
6.2 Decision-making in the context of governance and ownership
By harnessing the platform of corporate governance, both individual and institutional
investors can protect and direct their interests through their ownership of shares in the
companies in which they invest. Shareholder activism is one avenue to holding executive
decision-makers accountable for their actions. Gillan and Starks’ (1998:12) research on
shareholder activism and the influence of institutional investors on corporate governance
highlights how the separation of ownership and control within companies shifts power
into the hands of shareholders based on their share of ownership to influence companies
and markets (Ibid, 1998:10). Institutional investors, due to their concentration of
ownership, have the ability to exert both internal and external influence on their
investments and investments markets. Examples of influence include the appointment
and monitoring of the board of directors, as well as influencing management
remuneration and incentives (Gillan & Starks, 2012; Victoravich, Xu & Gan, 2013;
David, Kochhar & Levitas, 1998; Croci, Gonenc & Ozkan, 2012). In addition,
institutional investors have the potential to influence external decision-making, providing
market signals from the trading activity of a company’s shares by selling, holding or
buying more (Piotroski, 2014).
Encouragingly, shareholder activism is reportedly on the rise in South Africa (Holmes,
2014b). Institutional investors are increasingly holding companies accountable for
governance and executive remuneration policies (Duncan, 2014; Mergence, 2014;
Element Investment Managers, 2014). Individuals can also play a part in this process.
One notable example is Theo Botha, an individual investor who has come to prominence
as a shareholder activist in the South African market, holding boards accountable to good
governance and reporting (Viviers, 2014). Although he is one of the very few public
activists in South Africa, there are similarly minded civil society groups that have
emerged in other markets. ShareAction, formerly known as FairPensions, is one example.
Founded in 2005, it is a non-profit organisation involved in campaigning, policy-making,
research and investor engagement, serving the pension funds sector of the UK
Considering the dearth of asset owner engagement in RI principles and practice in South
Africa, a similar organisation could help to hold institutions responsible and educate
individuals about their rights as investors. An underlying factor driving shareholder
activism is investor education and in South Africa there is promising evidence of action.
6.3 Individual investor literacy
“The main forces for convergence [toward the reduction and compression of
inequalities] are the diffusion of knowledge and investment in training and skills.”
Regulation 28 of the Pension Fund Act requires all trustees of asset owner funds to
understand what responsible investing is and ensure that pension fund assets are managed
in line with ESG principles (National Treasury, 2011). In 2013, ASISA took a lead by
developing training for trustees, to be run through their Academy from 2014 onwards.
They have partnered with the Principal Officers Association and the International
Finance Corporation to spearhead the ‘Sustainable Returns for Pension and Society
Project’. This initiative will provide financial institutions with a framework as well as
tools to assist with the implementation of CRISA and compliance to the Pension Funds
Act (JSE, 2014).
Although this initiative addresses the topic of pension fund trustee literacy, there is
arguably a further need for the same knowledge and skills on the part of those who
contribute to pension funds. Reflecting on the structures of governance discussed above,
pension fund contributors may well demand a right to know where their contributions are
invested and how those decisions were made.
To gain deeper insight to the existence and need of these courses of action as well as
alternative approaches, a series of interviews were conducted using a consistent schedule
of questions with a selection of asset owners, asset managers, professional service
providers and industry stakeholders operating in the South African investment industry.
The interview schedule covered questions within four topics: institutional
acknowledgement of CRISA and/or PRI, decision-making, responsibility and investor
7. INSTITUTIONAL INVESTOR INTERVIEWS: FINDINGS
7.1 Institutional PRI/CRISA Participation
Aside from one participant (AO-N), all other interviewees were aware and
knowledgeable of both PRI and CRISA, regardless of their signatory status or direct
contribution to either initiative. Of the four PRI signatories interviewed, three of the
respondents personally or institutionally contributed to the creation and promotion of
CRISA including membership of the committee and public confirmation of their support.
All four PRI signatories, including the IODSA and ASISA, emphasised their institutional
and personal commitment to both the PRI and CRISA. Each signatory participant
provided detail on how they play transformational roles within their organisations as
individuals. Within their businesses this commitment has intentionally and proactively
adjusted their decision-making systems, processes and people to integrate the PRI and
Both non-PRI signatories, (PSP-N and AM-N) mentioned the cost of PRI membership
being a prohibiting factor. AM-N pointed out that the administrative requirements for the
PRI in terms of reporting and record keeping was onerous for small firms. PSP-N noted
that the events offered by PRI were usually in foreign countries as high cost that could
not be justified in comparison the other industry bodies like the CFA society. For both of
them the benefits of being a PRI member did not exceed the costs and/or risks of not
being a signatory. One of the two respondents commented that there appears to be a
degree of window dressing rather the real commitment for these initiatives in the South
Africa. (This sentiment was shared by a number of the PRI signatories as well.) Both
respondents however, were unanimous in their acknowledgement of the importance of
the principles of engagement and active ownership and the integration of ESG criteria in
their decision-making, where appropriate. One non-signatory respondent, referred to the
CRISA and PRI principles, particularly sustainability as “critical to any reasonable
7.2 Investment decision-making
Across all participants, limited numbers of highly skilled people were involved in the
investment decision-making process regardless of the differences and the size of the AuM
and the operational requirements of each organisation and its respective stakeholders. The
characteristic process of investment decision-making is a detailed, evidence-based
analysis of available investment opportunities, market fundamentals against a client’s
mandate. This information is then usually peer reviewed, before final decisions are made.
The process varies among participants from relatively informal to a multi-tier structured
In the case of the two pension fund respondents, investment decision-making is largely
delegated to internal investment committees that consist of selected trustees as well as
third party service providers. Delegated tasks include the design and monitoring of
mandates, proxy voting and engagement policies from which asset managers reference
their decisions and actions. Investment committees usually consist of selected financially
astute trustees, appointed asset manager representatives and asset consultants, with
trustees rubber-stamping their recommendations.
From all respondents, the unanimous purpose of investment decision-making is to
maximise the financial returns for their clients and their respective beneficiaries. That
being said, PRI signatories had varying commentary regarding the time horizon,
sustainability and risk adjustment of those returns, favouring an approach that focused on
the longer term factoring in ESG related risks. All three asset manager respondents
highlighted the importance of the mandate per client that they are expected to fulfil. Two
of the asset manager respondents went onto comment about the structure of remuneration
negotiated with clients defining activity and performance goals. They both felt that
inclusion of ESG criteria in their mandates and remuneration criteria would shift their
focus and activity to include ESG considerations more specifically.
In alignment with purpose of return, investment performance measures are
comprehensively judged against the criteria of industry benchmarks, such as JSE indices,
relative to other industry peers, expressed as a percentage return on capital invested.
Time periods also taken into account with 1,3 or five year rolling averages applied to
performance measures. It was interesting to note that asset managers are heavily
incentivised to beat industry benchmarks with potential to earn 500 per cent more than
their initial base fees should they manage to do so.
A further insight shared by a number of participants was the influence of asset
consultants over asset owner decision-making. As explained in the interview with AO-N,
investment analysis, asset allocation, oversight of asset managers and legal compliance,
such as Regulation 28 is delegated to their appointed asset consultant. Asset manager
respondents confirmed this phenomenon. In various interviews, the concentration of
influence due to the few asset consultants in SA was mentioned.
Two of the signatory respondents described themselves as “change agents” in terms of
the personal and institutional roles. The remaining two signatory respondents provided
details of what and how they have influenced their organisation’s leadership and
investment decision-making that included a number of similar initiatives across all
signatories. All participants agreed that institutional investors have influence over
financial markets, with some pointing out that the size of the investor or a specific
investment in a particular company is usually the determinant to the extent of that
influence. Even among non-signatories, it was felt that their influence has non-financial
impact, using the example of pension fund beneficiaries. In particular AO-N emphasised
that his role and responsibility as a financial expert and a trustee was to provide
beneficiaries the opportunity to retire with dignity, measured in terms of providing
beneficiaries with a sustainable income after retirement.
A number of participants raised the negative impact that results from what they called
“absentee landlords”. This term describes asset owners that assume a passive approach to
their investments, “abdicating” their responsibilities of ownership to appointed third
parties, interested only in returns disconnected from the fundamentals of an investment’s
long-term sustainability. The consequence of this is investments where management is no
longer accountable to shareholders and other stakeholders and could lead to abuse of
power, resources and the destruction of investor value.
In terms of fiduciary duty, all participants acknowledged levels of responsibility to act
honestly, focussed to deliver on their client and beneficiaries expectations. For both asset
managers and professional service providers, personal and institutional reputation is a key
determinant of business success in the investment industry. For asset owners, the
unanimous duty is to protect and enhance the retirement income for beneficiaries. Each of
the interviewees was able to describe the existence and active practice of governance
procedures within their respective organisations. In their understanding, the only
individuals who faced direct exposure to liability (excluding gross negligence) were
pension fund trustees. To mitigate risk, participants confirmed that their institutions had
professional indemnity insurance in place.
7.4 Investor participation in investment decision-making
Investment decisions made by asset manager respondents are disclosed to their asset
owner clients on a regular basis. Communication takes place either monthly, quarterly
and/or annually with written reports, presented face to face, or alternatively via email or
published. In most cases these are kept confidential to the asset consultant and the board
of trustees of the asset owner. Based on asset owner request these reports are sometimes
made available to individual contributors and beneficiaries via email, post or on the client
or asset manager website.
Asset consultant and asset owner participants were acutely aware of the demographic
profile of their clients and beneficiaries and base their calculations of risk and funding
requirements against this information. Unless this information is provided in the client
mandate, asset managers are not aware this information. The mandate usually describes
the level of risk the client is prepared to take and uses the mandate to frame all
investment decisions and options provided to individual contributors.
The majority of participants took clients non-monetary interests into account by client
demand, but the instances of this were rare and in those few cases very specific.
Examples of these included ethical filters as well as policy driven exclusions from their
investment portfolio. In the case of AO-N and PSP-Y’s clients, pension fund contributors
were offered a choice of investment options, based on their appetite for risk, with
reference to their age or stage of life. Both respondents highlighted that the contributors
take-up where investment choices were offered was surprisingly low – 36% of
contributors of AO-N’s fund made the choice and only 20% in PSP-Y’s experience.
7.5 Investor education
In terms of education, all respondents, particularly IODSA and ASISA, play a role in
communicating the importance of investing for the long term. Asset consultants appear to
play the most active role out of all respondents, developing training material, distributing
reports to asset owner clients from appointed asset managers and in the case of PSP-Y
and ASISA running regular training sessions with pension fund trustees. Asset managers
mentioned that they provide additional training opportunities to clients by inviting them
to industry forums and from one participant joining them for engagements with investee
executives. Training also extends to contributor level, usually packaged in the form of
quarterly or annual reports or seminars on retirement or investment.
7.6 The risks and rewards of democracy in investment decision-making
The final two questions posed to all respondents addressed the topic of individual
contributor participation in decision-making processes, asking for their perspective on the
potential risks and rewards of such an initiative. In terms of risks, respondents were
unanimous in their resistance to increasing investor participation in decision-making
processes. One reason for the resistance included the need for more time and more
resources to facilitate investor interaction limiting decisiveness and response to market
changes. A further reason was the potential disempowerment of the financial specialists
and disregard for the detailed analysis of each decision made. Common concerns raised
included the potential lack of participation from individual investors due to a combination
of lack of understanding or interest in the complexities of investment decision-making.
For two of the interviewees, an increase in transparency could result in the divestment
from certain companies that may undermine the long term returns of the investors’ fund,
affecting the soundness and stability of financial markets and encouraging short-termism.
In summary, the general view was that investment decision-making should be “left to the
professionals” or else the process would be “inefficient and chaotic” driven by “emotion
and sentiment” when was is needed is “financially literate, prudent decisions for
(individual contributors’) future.”
In terms of rewards however, most participants noted that increasing participation and
transparency with a wider audience would increase institutional investor accountability to
ownership responsibilities and highlight the importance of ESG criteria in investment
decision-making. The increase in participation might encourage an increase in demand
and investment choice, fundamentally improving the financial literacy of individual
contributors. In reflection of the risks and rewards, interviewees pointed out the
complexity of the investment process and that an increase in participation would require
communication to be clear and as simple as possible. One respondent surmised that
greater participation may encourage individuals to get more involved with their
investments by understanding how their “money makes a difference” potentially inspiring
them to save more.
The findings support the conclusions of previous studies into the factors influencing the
practice of responsible investing in South Africa (Viviers et al, 2008). There are however
two additional factors not previously identified that warrants further research – the
influence of asset consultants and the structure of institutional investor remuneration.
“With great power comes great responsibility.” (Voltaire, 1832)
Legal, regulatory and normative frameworks in practice in South Africa’s financial sector
are modelled on current global practice. Significant public sector participants in the
institutional investment market, such as the GEPF and the PIC, have played a catalytic
role in promoting the principles of normative frameworks like the PRI. Furthermore,
ongoing instances of financial scandals, company failures and destruction of investor
value and loss of stakeholder trust, herald the need for more inclusive approaches to
investment decision-making and active ownership.
The Marikana massacre is a glaring example of the complexity of the challenges South
Africa faces from the perspective of society, politics, economics, finance and governance.
While companies seek to generate profit from commercial activities for their
shareholders, the impact of those activities stretches wider and deeper than financial
return. A lack of due care for the interests of people and the environment impacts
economies and communities immediately and for generations to come.
Institutional investors have a significant role to play in light of the responsibility they
assume as agents of other people’s money. Their direct exposure to the dynamics of
financial markets leaves them best qualified to inform and educate their clients regarding
the risks, rewards and reality of investment decision-making. In assessment of the
evolution of the legal, regulatory and normative codes, in particular King III, PRI and
CRISA, professional investors should assume the wider responsibility of educating their
clients about the potential financial implications as well as the social and environmental
impacts of their choices. Similarly, asset owners should assume the responsibilities of
ownership over the impacts of their investments in their search for investment return. In
future, this may well include the responsibility for the reparations of loss and damages
related to how that profit was derived.
It's a matter of concern that only a fraction of private sector institutional investors
subscribe to the PRI and CRISA. Indeed, research suggests that there is little evidence of
commitment even from those that identify themselves as supporters (IODSA, 2013).
Market incentives exist to encourage private sector participants through the substantial
asset bases of public sector asset owners, but at this point there is limited pressure from
private sector asset owners and shareholder activism in South Africa (Viviers, 2014). A
commitment to normative principles and the practice of governance in unison with
regulation and legislation can provide a viable platform for change, but reform needs to
take place from the level of individual investment decision-makers – both contributors
and professionals - through to the institutions that they appoint or represent, respectively.
In South Africa as well as in the rest of world, deep socio-economic challenges prevail.
The collective participation of all investors present an untapped force to shape the flows
of capital. Such a shift will challenge the assumptions of conventional investor decision-
making potentially offering new, more democratic approaches to how capital is deployed.
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