8 Special reportAsset management The EconomistNovember 14th 2020
21markets, it is usually to tidy up its capital structure (lengthening
the maturity of debt, say, or buying back shares) or to build cash re-
serves in times of stress, such as now. It is management teams that
now do most to allocate capital.
This makes stewardship more important. When it works, in-
vestors engage with a firm’s managers to verify that the business is
well run. The problem is that the incentives to be good stewards
are weak. An asset manager that bears the cost of stewardship will
capture only a small share of the benefits. A paper in 2017 by Lucian
Bebchuk, Alma Cohen and Scott Hirst, a trio of law professors,
found that asset managers mostly avoid making shareholder pro-
posals, nominating directors or conducting proxy contests to vote
out managers. Index funds are especially at fault. Their business
model is to avoid the costs of company research and deep engage-
ment. The law professors reckoned that the big three asset manag-
ers devoted less than one person-workday a year to stewardship.Bosses and agents
The growth of index investing is likely to have raised the agency
costs of asset management. Bosses may be either too timid or too
lax, depending on the circumstances, to act in the best interest of
shareholders. They may shun profitable projects because it is hard
to persuade disengaged owners that the rewards justify the risks.
Or they may be careless with shareholders’ money. Some research
finds passive ownership aggravates these problems. A paper by
Philippe Aghion, John Van Reenen and Luigi Zingales finds that
companies with a larger share of active owners are more innova-
tive. They find no such link between index ownership and innova-
tion. Other research suggests that indexing makes it more likely
that managers will pursue ill-judged mergers.
Investors now care more about what they are investing in. The
growth of environmental, social and governance (esg) investing,
which selects companies on how they score on such matters, re-
flects this. Some asset managers suspect esgis a fad, but many do
not. An esgscore will soon be a requirement, says one. It will even-
tually be as important to a firm as its credit rating, says another.
“Sustainability” is increasingly seen as a risk factor for long-term
performance. “If your firm is more sustainable, you will get the
best people, customers and regulators,” says Christian Sinding,
boss of eqt, a Swedish private-equity firm. These are the firms you
will want to own in ten years’ time, he adds.
esg looks like a lifeline for active fund managers. “Active has a
big advantage over passive when it comes to esg,” says Ashish Bhu-
tani, chief executive of Lazard Asset Management. Passive funds
can only tick boxes. Some environmental matters, such as a firm’s
carbon footprint, can be quantified, but others cannot. The social
criterion requires qualitative judgment about a firm’s hiring prac-
tices, its efforts to reduce inequality or the broader impact of in-
vestment projects. Governance is somewhere in between. Good
analysts have a deep knowledge of companies and their manage-
ment. They know things that are hard to quantify and cannot be
found on a financial statement or a boilerplate disclosure.
The challenge for active managers is to show that sifting firms
by esgor any other qualitative criteria will make for better port-
folios that justify a fee premium over an index fund. A greater fo-
cus on the long term would be welcome for both companies and
their shareholders. It is a stretch to claim that active managers in
the main are great stewards. They are not. Most are (or at least have
been) either transient owners, trading in and out of faddish stocks,
or closet index-huggers.
The best-performing stockpickers are both patient and strong
in their convictions. They hold stocks for long periods in a concen-
trated portfolio. It is in part a quest for these traits—commitment
and patience—that has persuaded a lot of investors to flock into
private equity and other closely held assets. 7T
he notionof the “first 100 days” as critical for a new adminis-
tration goes back at least as far as Franklin Roosevelt. He first
used the term in a radio address in 1933, shortly after becoming
America’s 32nd president. Private equity has its own version. The
100-day plan sets priorities for a bought-out business. The new
owner looks for “quick wins”—standard remedies for the most
glaring operating problems. Fixes may include updating comput-
ing systems, slimming the array of products or closing loss-mak-
ing divisions. The plan also prescribes the easiest ways to raise
cash to pay off hefty debts used to acquire the firm.
The promise of private asset management (buy-out funds, priv-
ate debt, venture capital and so on) is that endurance will be re-
warded. Investors in private equity must lock up their money for
years; they cannot easily sell out. Big stakes in private assets trade
quite rarely. But there is an upside. Private managers are able to eke
out better returns than would be possible if their assets were
traded each day. Investors in the public markets like predictable
short-term profits and strategic certainty. They are too skittish to
invest in a corporate turnaround. If the boss of a listed company
unveiled a 100-day plan, it might spark a run on the shares.
That is the sales pitch—and plenty of investors buy it. Desper-
ate for returns, pension funds have piled into private markets in
recent years. A survey by Morgan Stanley finds that 64% of institu-
tional investors plan to increase their allocation to private equity
this year and only 5% to reduce it—a net balance of 59%. The bal-Taking back control
Privates are what listed assets are not: niche, illiquid and fee-richPrivate markets