RI Interview: Professor John Kay on how his Review can be a catalyst

One-to-one with the author of government-backed review of short-termism

Professor John Kay tells Responsible-Investor.com how his review into equity markets and long-term decision-making could prove a catalyst for changing asset management for the better.
John Kay, one of the UK’s leading economists and public policy figures was a natural candidate when the government was looking for someone to head up a review into equity markets and long-term decision making. The subject is a difficult one to grapple with because of the moving parts of the investment chain. But Kay, a widely-published author, is known for his incisive insight on finance issues, and, as a Financial Times columnist, the ability to communicate his thoughts succinctly. With the dust settling following its publication last week, Kay says he is hopeful the review can stimulate change in the asset management industry by prompting a change of culture. His findings certainly garnered serious, top-level interest from both the investment industry and the wider financial sector. The report presentation at the Royal Academy of Arts in London was a standing room only event. The review is one of just a few weighty financial market analyses published over the years which has an easy, flowing style. Kay builds his case like an accomplished essayist and the reader is drawn along by the train of argument. It’s a long report and will reward study. Reactions to the review were not universally positive though. One (very) senior figure told RI that Kay appeared to be looking at the investment world as it was in 1980. And James Featherby, the Church of England ethical committee chairman (writing in a personal capacity) argued on these pages that the review lacks punch.
Kay himself, however, says the reaction he has received to the 113-page report has been “very positive”. He told RI: “My sense is that an awful lot of people in asset management and asset holders would like to see this as a catalyst.”He said people he’d spoken to in the investment industry weren’t “defensive and status quo” on the report, noting that the consultation had received a very healthy 84 responses. Kay’s report highlights the need for better oversight of fund managers by asset owners, more long-term investment decisions, concentrated portfolios and narrative corporate reporting. And he says he wants to focus on the role of the asset owner or ‘holder’ to stimulate better behaviour along the investment chain. This, he says, comes down to how they award mandates. He points to the specific proposals laid out in best practice guidelines for asset holders.

“We’re talking about a cultural and philosophical change”

These guidelines are somewhat buried in the lengthy report, but they could prove to be a key ‘output’ of Kay’s findings. They call for owners to be “proactive” in setting mandates and for them to set mandates which focus managers on achieving absolute returns in line with beneficiaries’ long-term investment objectives, “rather than short-term relative performance benchmarks”.
It says asset owners should review manager performance no more than necessary and “encourage and empower” managers to engage with companies. Kay believes these few paragraphs should form the template for investment in the future and that the industry would do well to take them on board, but he notes: “It’s an evolving process – to see what a good mandate looks like.” The pensions industry now at least has the intellectual backing to start doing things differently.
Asked about whether he has underplayed the pivotal role of investment consultants in investment decision-making in the UK, Kay is clear: “I think the investment consultant role has emerged because of a system that isn’t working well.”

He argues that the proliferation of advisors is the result of a lack of trust and confidence along the entire chain.
RI put it to Kay that no link in the investment chain would voluntarily exit from its business. Kay replied that people at each stage of the investment process needed to ask themselves: “do we need to involve other people?”
He added rhetorically: “How many layers of asset management do pension funds actually need?”.
Nonetheless, Kay rejects the idea of professional pension fund trustees, saying: “The role of the trustee is not to be a second level of asset manager.” He said trustees had a specific role to play: to pick good asset managers.
Kay says he would have liked the report to have tackled the fragmentation in the asset owner sector, where sub-scale holders of assets lack the heft to sway asset managers and consultants. An idea like asset pooling “must be the way ahead” he says, pointing to the new UK government initiated, defined contribution workplace pensions system, NEST, as a way forward.

Critics have noted that the Kay review very deliberately contains no new policy levers to prompt change. He explains the rationale: “Fundamentally what we’re talking about is a culturaland philosophical change and you can’t legislate for that.” But Kay is confident in the specific measures that he has put forward: the investor forum, the mandate best practice guidance and the proposal to review the concept of fiduciary duty. He is surprised that people haven’t made more of this last point, which he says could help to remove obstacles, perceived or otherwise, to more engaged investment.
Fast forward five or 10 years, how will we look back on Kay? Will it mark the moment when the institutional industry finally woke up to a chance to untangle the complicated and often unproductive chain of rent-seeking investment intermediaries, or will it be a missed opportunity? What is certain is that Kay has provided a framework for a cultural shift. The UK government will respond with its proposals later this year, but as with any incentive to a behavioural shift, the acceptance of the need to change and the will to do so have to come from the investment industry itself; starting with the asset owners on behalf of their retirement savings, insurance and investment clients.