Consultant, investor and author David Pitt-Watson occupies a unique niche. “How and why do businesses take the sorts of decisions that they do? What are the ones that work? What are the ones that don’t work?”
Every career is unique, but some are more unique than others. David Pitt-Watson possesses one of the latter type of careers. The co-author of The New Capitalists, Pitt-Watson co-founded Braxton Associates, eventually bought by Deloitte Consulting, and later became head of the shareholder activist funds and director of Hermes Fund Managers, establishing Hermes as a leader in responsible investment. He was author of a critical report into the UK pensions industry in 2012 and is currently an Executive Fellow at London Business School. Along the way he has advised politicians and policy makers, including Prime Minsters Tony Blair and Gordon Brown, and was Assistant General Secretary of the Labour Party.
Given Pitt-Watson’s career it comes as a slight surprise that he is now based at a business school. The succession of jobs, initiatives, passions and politics has been unrelenting since he graduated from Stanford with an MBA in 1980. Before then he studied Politics, Philosophy and Economics at Queen’s College, Oxford. “I have never understood the notion that there is a divorce between the real world and the academic world. I don’t get it. The academic world is there reflecting, explaining, understanding the real world,” he says. “When I did my MBA at Stanford that was the way everybody thought about it. All the big businesses in Silicon Valley today either had something to do with Stanford or if they didn’t, they had something to do with Berkeley.”
At Stanford in the late 1970s, Pitt-Watson did courses in the statistical analysis of investments. At the time this was seen as a radical and interesting new approach. Now, Pitt-Watson suggests it has taken over to a point that is, in practice, unhelpful. The development economist Gerald Meier was one of the Stanford professors who proved influential. “Meier always made sure we didn’t mistake theory and practice” he says.
The bearings of his career compass slowly changed. “I went to university thinking I’d be a history teacher and, maybe, do some politics on the side. But, as I studied it just seemed to me that the most interesting questions of the world were about how the economic and the business system works,” he recalls. “And so, I wanted to learn about that and was lucky enough to get a scholarship to Stanford. It was a good course from that point of view because it wasn’t entirely devoted to case studies, it had some theoretical study, about 50/50. I was just intrigued about how it is that business works. How and why do businesses take the sorts of decisions that they do? What are the ones that work? What are the ones that don’t work?”
Pitt-Watson left Stanford and entered the world of strategy consulting. He co-founded and later became Managing Director of Braxton Associates. Braxton, where Pitt-Watson eventually spent 17 years, was later purchased by Deloitte and evolved into Deloitte Consulting, one of Europe’s largest strategy consulting firms. “Braxton hired me as one of the original gang and so I’ve twice joined companies that were just starting up or starting up a new enterprise, both at Braxton and at Hermes. In both cases, it was really good. You get the chance to shape the enterprise a little,” says Pitt-Watson. “I did some work as a consultant to Hermes and then later joined Hermes when they set up the shareholder activist funds and the Equity Ownership Service. So, I suppose, in some ways, there’s always been a bit of curiosity to do something new, to explore how exactly the system works. Sometimes I do look back and say, how did I end up here?”
In 1999 Pitt-Watson joined Hermes Fund Managers as commercial director of their newly formed shareholder activist funds, the Focus Funds. The funds grew to be the largest of their kind in Europe. Pitt-Watson became head of the Focus Funds and a director of Hermes in 2004. He then established the Hermes Equity Ownership Service (HEOS), a service to pension funds which aims to ensure that the shares they own are used to promote good management practice and sustainable investment. HEOS now advises on over £80 billion worth of assets.
At Hermes, Pitt-Watson wrote The Hermes Responsible Ownership Principles. The Principles have a forthright and persuasive simplicity. They lay out the expectations of Hermes of the companies in which it invests and vice versa.
“At the most fundamental level, companies should economically, efficiently and effectively provide goods and services that individual clients and society need or want. In general this can only be achieved sustainably if in doing so they create value over time for their shareholders,” The Principles begin. “In order to succeed in the long-run, companies will need to effectively manage relationships with key stakeholders and have regard for the environment and society as a whole. Companies adhering to our overriding principle will not only create sustainable value for their shareholders, but also benefit stakeholders, the wider economy and society in which they participate.”
Mind the gap
As a calm and considered statement of the basics of how companies should be run in the 21st century, The Hermes Principles attempt to bridge the often sizeable gap between investors and those who actually run companies. Says Pitt-Watson: “The first part of my career was in business: with people in large, complex organisations who made things and delivered services. You go to the City to be an investor and it’s really rare that you bump into anyone that’s got any of that experience at all — really, at all. So, you have two worlds: one that has come from this investment world, and another that’s come from the business world, and they suddenly meet up in the middle. Think about a chief executive: you take over responsibility for the company, when did you ever meet a shareholder before that day? It just doesn’t happen unless you were a finance director, and so you come with all these presuppositions of the way that this is supposed to work.
“If you’re an investor, the chances are, you’re interested, simply, in buying and selling shares. This is not in and of itself a bad thing, in fact it’s got many very positive aspects, but your world is so different from somebody who’s trying to run a big organisation. To run a big organisation, you need that clarity, voice, vision, organisational steeliness, leadership, and that just isn’t what a fund manager is thinking about or doing most of the time. That is where many of the problems arise.”
Pitt-Watson’s ideas developed still further in the book The New Capitalists (Harvard Business Review Press, 2006), co-authored with Stephen Davis and Jon Lukomnik. The book explained that shareholders today are not some separate “class”, they are millions of ordinary people whose life savings and pensions form the bedrock of the mutual funds, insurance policies and retirement plans which make the investment world go round. They calculated that these many millions of people — representing half the adult population of most developed countries — own between 40 per cent and 80 per cent of the outstanding shares on the stock markets of the developed world. “What it was saying was if millions of people own our companies, how come companies are not run for those millions of people? Companies do belong to all those people who have savings, and insurance and pension plans, but that ownership doesn’t stretch through the system. So, The New Capitalists was thinking about how that ownership structure can be made effective, and what things are happening that might help that process take place,” Pitt-Watson explains.
The Queen’s question
There is an air of can-do optimism about The New Capitalists. It is our money and the need for ordinary people to have an influence on how the system works appears compellingly logical. The book, says Pitt-Watson, helped change things. “Today, there are many times the number of people who are interested in these issues, than there were when The New Capitalists was written. They have a clearer agenda of what it is they’re trying to do. Some of the most interesting things are being done in countries where you would never have dreamed that it would have been done 15/20 years ago, and it is enormously rewarding to travel to a country like Brazil and be told your book was influential. But, do we have a financial system that is sensitive to and responds to the needs of the people that it’s trying to serve? No.”
Of course, The New Capitalists pre-dates the financial crisis. Now, Pitt-Watson and his co-authors are working on another book. One of the book’s chapters is tentatively titled, The Queen’s Question. The Queen, famously, visited the London School of Economics and asked why no-one, including its faculty, had seen the financial crisis coming. The uninspired answer was that everyone took the authority of someone else and everybody thought they were doing the right thing.
“Our new book is trying to say, look, if you think about the financial system, get practical about what it does that’s good and bad,” says Pitt- Watson. “So, we look at how things go wrong — including how you can abuse some of the techniques that you might be taught on an MBA or a Master of Finance course — and then we’re going to take a step back and say, well, if what we are trying to do is to construct the financial world, so that it does what we want it to do, how should we structure it? How should we regulate it? And also something I’m finding really interesting, how should we think about economics and finance, in a way that is helpful in addressing these questions?
“For example, microeconomics assumes that the customer will ensure suppliers act in good faith. If they do not, if incentives mean suppliers don’t serve customers well, you’ve got a real problem, and things will go wrong. In the financial crisis they went catastrophically wrong. Bankers behaved in ways which were to their advantage, but not to those of their customers and the outside world. The question then is how do you put in systems to stop them from going wrong again? How do we get the financial system structured so that it can deliver what the Hermes Principles advocate, that you make profit because you serve customers and society well.”
Taking the air
Pitt-Watson detects that change is in the air, progress is being made. Business responsibility is now debated and reported on by companies. He believes that relationships between CEOs and fund managers are much improved and that, in the area of UK corporate governance, there has been a transformation in the past 20 years with boards of directors thinking about their accountability and putting appropriate checks and balances on the board.
“If you’d said to somebody in 1990, we’re going to make sure that there is a proper election for anyone who stands for a board of directors, that sometimes people are going to lose these elections, that remuneration and nomination is going to be taken out of the hands of the executives altogether, that we’re going to have definitions of independence and more than half the board members will be independent, most people would have said there is absolutely no chance. But, actually, corporate Britain did allow it to happen, and we should feel really proud of that, because it’s a big step forward, and the performance of companies during my time in business has massively improved. But is there lots still to be done? Yes, absolutely.”
The dispersal of ownership continues to concern Pitt-Watson. Pensions are invested in thousands of different companies. Keeping track of such vastly diversified portfolios is all but impossible for fund managers, let alone the people whose money is invested. Such lack of control and distance between the investor and reality bears similar hallmarks of the horsemeat scandal of early 2013, where the supply chain was so long that nobody knew who was responsible. The same distance can exist between the saver and the companies they ultimately invest in. “How do you manage through such a long chain, to be able to ensure that that sense of ownership, of duty to the original saver, is still to the fore?” asks Pitt-Watson. “You can have systems that go wrong as small losses of responsibility take place as management responsibility is delegated from one bit of the system to the next. It doesn’t need to be bad people for the system to be bad.”
Pitt-Watson’s research into the UK pension industry shows another aspect of how important it is to design financial systems which work for the customer. Perhaps the most damning analysis compares what happens when a 25-year old Dutch person and a British person of the same age start to save for their pension. If they put in exactly the same amount of money every year, retire on exactly the same day when they’re 65 and their life expectancy is exactly the same, the Dutch person will receive a pension that is 50 per cent higher than their British counterpart. Simply, the system in Holland is efficient and effective and the system in Britain isn’t.
“It’s like British people flying around in planes with propellers when the Dutch have jets,” says Pitt-Watson. “Massive improvements are possible by thinking about how it is that you would structure a financial system.” Pitt-Watson admits that a neat solution is not easily found. Systems are veritable super tankers. Yet, he remains a positive Aberdonian rather than the more sceptically inclined stereotype. “Opening up the debate about what works and what doesn’t work; thinking through this with practitioners, regulators and customers; having a change in the mood in the way that people think about this: all of those sorts of things seem to me to be entirely positive. Of course, there are lots of vested interests to do nothing, but there are lots of good people out there who would like to bring about change.”
The upside of improved financial systems is not a prosaic economic detail; it touches lives. Over six per cent of Britain’s GDP goes to savings for private pensions every year. A 30 per cent improvement to take the performance of the British system closer to that of the Dutch system could amount to more than two per cent of GDP. “By changing the British pension system, you would, over a generation, contribute as much to the welfare of British people as the entire supply of North Sea oil and gas. It’s a hell of a lot easier to change the pension system than it is to get North Sea oil and gas from 5,000 feet under the ground and 600 feet under the sea.”
David Pitt-Watson spoke at London Business School's Global Leadership Summit on 20 May 2013.
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