Investors need independent directors to represent them, says INREV. Then let them put their money where their mouth is, say fund managers. Shayla Walmsley reports
INREV's recent call for changes to the directorial make-up of non-listed funds came from a putative paucity of ‘truly' independent directors capable of protecting investor interests, despite 84% of funds having non-executive boards.
Currently, says Alasdair Evans, chief operating officer of Hermes Real Estate, the fund manager owned by the £35.3bn (€42.5bn) BT pension scheme, investor representatives appear, if at all, on sub-board advisory committees with few or no decision-making powers.
"The advisory committee is thought to be sufficient," says Evans, who also chairs INREV's corporate governance committee. "It is in most cases - especially if investors have approval rights. But when, rather than moving as one body, investors move in different directions, an independent director can act as referee."
Even supporters of the proposal might quibble with narrowing the independent director's role to mediation. They are there to ask awkward questions, according to Douglas Crawshaw, senior investment consultant at TowersWatson.
"If something is tricky, having only internal people and processes means it isn't necessarily being addressed properly," he says. In contrast, if a non-executive director were to raise the level of leverage in a fund as an issue, for example, it would "put the fund manager in the firing line".
Of course, the assumption underlying INREV's call is that independent directors know what they are doing. But even some consultants are not quite convinced. Marcus Hurd, senior consultant at AON, acknowledges that independent directors can bring expertise, including on issues affecting pension funds.
But do they make better directors? Not necessarily. They are expensive, for one thing (though they are paid by the fund, not the fund manager). For another, they tend to be more risk averse, he claims, with governance high on their list of priorities. It is not necessarily a bad thing, of course. "It depends if it clouds their view of what is right for the fund," says Herd.
The available talent pool is a significant issue here. When Evans first raised the issue of independent directors at an INREV event earlier this year, it was in the context of an industry shedding talent. Citing gaps in corporate governance as a threat to the competitiveness of non-listed real estate, he pointed out the changes in management during the downturn had created a pool of senior managers who would be available for non-executive roles.
"Having people who understand the market, investment and the fund well is vital," he says now. "You want high-calibre people and it isn't as easy as you'd think to pull them out of the market. You have to look hard and carefully."
In the meantime, one question INREV has yet to deal with is what fund managers can do to prevent investors becoming counter-productive. "Small investors could bog everything down," says Crawshaw. "Some managers have a rotating chair, which lets them get on with running the fund without investors chipping in." He says some fund managers have offered a seat to consultants, including TowersWatson, despite the potential for a conflict of interest.
The problem with investor involvement in fund operational management, said on fund manager during the INREV panel discussion cited earlier, is that "acting only with the approval of investors is a recipe for disaster".
There is also the potential for one element of good practice to conflict with another equally good element. Alignment of interest - which also appears within the INREV recommendations - is meant to ensure fund managers view their investors' interests as their own because they share in the performance.
Asked what he thought of the director proposal, Jens Friedemann, a spokesman for fund manager IVG, says: "I disagree completely. Every fund has its own management and its own representation of shareholders. Independent trustees are not engaged with their own money. They don't share the risk."
In any case, in German Spezialfonds targeting institutional investors, "not single decision is made without their consent", he says. "They decide what to do. The days when managers said, ‘We'll do this and we'll do that' are long gone."
Some fund managers might well long for those days to return. Others speak of the danger of "governance for governance's sake". Not that the suggestion was prescriptive in the first place, but pension funds' acceptance and adoption of it is likely to be even less so. It seems the closer-knit the community of investors, the less likely they are to see the value that could to be added by increasing the number of independent directors.
What about increasingly prevalent club deals involving four or five investors, each with the same amount of clout when it comes to decision-making, for example? One champion of club-deals, Michael Nielsen, CEO of ATP Real Estate, the property subsidiary of the DKK420bn (€56.4bn) Danish labour market supplementary pension scheme, says the benefits independent directors, but only in specific instances.
"We will take a case by case," he says. "Sure, there will be funds and opportunities where it would be perfect to have some independent directors on the board. In countries we're not that familiar with, it would be a good idea. Otherwise, we agree governance with fund managers and we agree restrictions on that governance when we set up the fund.
"It depends on the profile of the fund, and on our knowledge of the fund manager. If we have long experience of the fund manager, we might not require an independent director on the board."
But with neither fund managers nor pension funds calling for the introduction of independents, it is hard to see how they might become a standard feature of funds in future. Yet the shift in the balance of power from fund managers to investors is beginning to show. Even if not much can be done with existing funds, new funds are likely to be marginally more receptive to the idea.
"In any development of new ideas, the more people use them, the more they become the norm," says Evans. "Strike now."
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