Seven Questions: Colin Melvin
One of the world's most influential investors says that changing behavior on Wall Street will take more than regulation.
The global financial crisis has wiped out billions in pension schemes and retirement savings. But Colin Melvin, CEO of Hermes Equity Ownership Services Ltd., is optimistic about the future of the $100 billion-plus under his advice. Melvin is part of an emerging class of investors who look to change, improve, and remold the companies they invest in -- boosting, they argue, the firms' value and competitiveness in the long run. The model has gained particular attention after the financial crisis brought to bear the short-term risk taking that had come to characterize Wall Street. Now, investors from New York to London are looking for new models, and Melvin's is one they've found. Foreign Policy's Elizabeth Dickinson sought Melvin's insight on investment strategy, his reaction to recent G-20 actions to remold the global financial architecture, and the future landscape of the financial industry.
The global financial crisis has wiped out billions in pension schemes and retirement savings. But Colin Melvin, CEO of Hermes Equity Ownership Services Ltd., is optimistic about the future of the $100 billion-plus under his advice. Melvin is part of an emerging class of investors who look to change, improve, and remold the companies they invest in — boosting, they argue, the firms’ value and competitiveness in the long run. The model has gained particular attention after the financial crisis brought to bear the short-term risk taking that had come to characterize Wall Street. Now, investors from New York to London are looking for new models, and Melvin’s is one they’ve found. Foreign Policy’s Elizabeth Dickinson sought Melvin’s insight on investment strategy, his reaction to recent G-20 actions to remold the global financial architecture, and the future landscape of the financial industry.
Foreign Policy: Wall Street’s management culture has been particularly demonized for its role in provoking the the global financial crisis. What’s your take? What were the fundamental problems with the financial world, exemplified by Wall Street, that led to the present downturn?
Colin Melvin: I think there was a lack of accountability of quoted financial services companies — public companies — to their ultimate owners, the shareholders. Another factor at play is the culture within Wall Street and the city of London, which focuses on short-term matters and returns. You have a situation where the link between the company and the end owner is mediated by Wall Street. And Wall Street is incentivized to trade rather than to own the asset. [Blame for the crisis] isn’t limited to the action or inaction of funds, but that’s a big part of it.
FP: Your firm, Hermes, takes a longer term view of managing assets. How does that strategy differ from the typical Wall Street approach? What are the benefits?
CM: Hermes is owned by the British Telecom pension scheme, the country’s largest. That gives us a much longer horizon since a pension fund’s horizon tends to be 15 to 20 years or more. We also though understand that it’s not possible to be a good long-term owner of a company simply to trade the shares.
Hermes’s Equity Ownership Services doesn’t actually make decision on buying and selling shares; we represent funds as owners of companies. My team decides whether to engage or disengage with companies. The kinds of discussions that we have with companies focus on the strategy in the longer term. We assess capital structure, we look at risk management — particularly from a long-term perspective including social, environmental and ethical risks, and we look at governance, broadly defined as the quality of the board, the nominations process for the board, the way that directors are paid, incentives. We focus on those factors we believe are linked to companies’ long-term profitability.
FP: You’ve had success this year when most other investors have taken a hit in the market. Do you attribute this to your different approach?
CM: We’re attracting a huge amount of interest. Banks have failed so spectacularly, and those banks had owners — they were you and me. It seems like somehow that ownership link has been broken, and we were unable to fix it. Now, large public funds are coming under pressure from governments to be better owners of companies. And that’s leading people to our door.
FP: The criticism of an activist approach to investing in companies is that outsiders might miss the insights that managers of companies themselves have. In essence, outsiders might make changes that appear to them as appropriate, but might in fact be the opposite. What do you make of this critique?
CM: We don’t seek to micromanage the companies; our goal is hold the management and the board to account for their performance. If there’s no problem, if the company’s doing well, they won’t hear from us. It’s just when there’s a problem that we’ll raise it.
Of course, it would be exceedingly disappointing if I knew more about the operations of a company than the board and the directors and senior management. However, we do additional research, and we commission people to help us understand companies from a long-term approach, and that’s quite unusual. Most people involved in the financial-services industry look at the short-term financials. If you were a CEO of a large company in the United States, your experience of talking to Wall Street would be pretty disappointing. You’d be challenged about next quarter’s earnings; you wouldn’t be asked about those things you’re thinking about day to day — the people in the business, long-term strategy. Wall Street isn’t interested in that. We are [interested], and we’ve assembled a team of people here who are able to challenge companies on those particular issues. So it’s a question of business knowledge and understanding, which again is very unusual in the financial-services industry.
FP: What do you make of the response to the financial crisis — particularly looking at the G-20 summit last month? What did they do right, and where did they fall short?
CM: The do right bit got me there. I think it’s encouraging that people got together to consider solutions. The worrying bit is that the big idea appeared to be some sort of coordinated regulation. We won’t solve this problem through regulation. Experience has shown that if you seek to prescribe behavior through regulation, financial markets will find a way around it. What we’re talking about is behavior. It’s culture. I don’t think you can solve that by regulating. What we can do at a regulatory level — and there was an optimistic note in the G-20 on this — is that we can regulate to produce open, fair, and transparent markets.
FP: What are some of the short-term things that could or should be done to restart the markets?
CM: There are regulations in some markets that limit the extent to which shareholders can work together. In some cases, this is sensible, but for longer-term discussions, clearly it’s in everyone’s interests that the shareholders are able to work together to talk to companies. Otherwise, you get multiplicities of replicating, low-level conversations. Far better if they get together and share resources. That’s better for the companies they’re talking to as well, because the conversations are of a higher value.
Thinking a little more creatively, we might look to the definition of fiduciary duty. In many markets, particularly common law markets, there’s a duty of trust, fiduciary trust, for example on the trustees of the pension fund to work to the benefit of the beneficiaries. So if you’re a beneficiary of a pension scheme, there are people to whom your wealth is entrusted, and they have a duty to look after your interests. That duty is interpreted usually as adding value to the funds in the short term. Clearly, that’s a problem. So why don’t we look to this definition? Why doesn’t the U.S. or the UK come out with some sort of statement: This is what we mean by [fiduciary duty]? A legal opinion would assist trustees in taking a longer term view of their role.
FP: Five, 10 years from now, what will the financial industry look like?
CM: We have a very important moment to implement this [investment model]. If we have another sustained bull run, then much of this will be forgotten and [London] and Wall Street will have a great time spending the assets of their clients. Perhaps that’s a little strong, but you know what I mean.
Over the last 10 to 15 years, [London and Wall Street] have been able to overtrade because they make money from transactions — the more transactions there are, the more money they make. I hope that will change, and that the clients of the investment industry and the end owners will understand and appreciate the self-interestedness of being better owners of the assets, and being more attentive clients. If companies are more accountable, they will perform better. And if funds are invested in a more sustainable way, that’s good for all our wealth.
This article reflects two corrections: We originally stated that Colin Melvin manages a fund of $100 billion. In fact, this is the amount under his advice. Nor does Colin Melvin classify his model as activist investing. We regret the error.
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