Press Office Feature : Stewardship – Substance Over Form
|Company:||Foord Asset Management|
|Posted:||09 Mar 2016|
The United Nations-supported Principles of Responsible Investing (PRI) and the Code for Responsible Investing in South Africa (CRISA) are examples of voluntary codes aimed at encouraging investors and institutions to consider sustainability and governance issues.
Importantly, subscribing to these principles is meaningless unless their substance is truly inherent in the investment philosophy and process.
Form over substance characterised much of the initial industry response. That balance is now slowly moving in the right direction.
Because non-financial factors can directly influence the long-term sustainability of a company’s future income streams, when analysing companies as active shareholders, one must always consider the impact that ESG issues will have on valuations and to discern the true risk of permanent capital loss.
Clearly, activism has its roots in the need for change, a challenge to the status quo, a sense that existing circumstances are unsatisfactory, or not in the best interests of stakeholders.
While the implications of the activist fund manager concept are perhaps not as ubiquitous as its socio-political equivalents, activist fund managers share similar ideals in pursuing change in the best interests of their investors.
Investors entrust the management of their savings to professional fund managers.
These fund managers, in turn, are mandated to invest those funds in various assets, including the shares of companies listed on exchanges both locally and abroad.
In carefully selecting such shares for inclusion in investment portfolios, fund managers must have regard to the fundamental value inherent in the business based on their rigorous analysis.
Shares represent an ownership interest in companies that utilise tangible and intangible assets, and employ human and working capital, to produce a future cash flow stream.
The quality of the company’s management team in leveraging those resources to maximum effect should not be underestimated.
Accordingly, diligent fund managers should assess the quality of corporate executive teams charged with the operational and strategic management of a company.
An inherently great company saddled with poor or ineffective management is unlikely to contribute to investor returns as it should.
It is these companies that must be the primary subjects of shareholder activism.
Where corporate boards of directors or executive teams fail to include the requisite skills, or where they fail to adhere to corporate governance precepts, or where they fail to execute their mandates in the best interests of shareholders, professional fund managers should not be idle and should take company directors to task.
Such shareholder activism can have many forms. While most professional fund managers have policies that direct them to attend and vote on resolutions tabled at company annual general meetings, often more needs to be done.
Company management should be privately engaged to implement change, failing which public pressure should be applied.
Further, the South African Companies Act affords shareholders with a sufficient beneficial interest the right to requisition a special general meeting of shareholders.
Activist shareholders can use this mechanism to propose a variety of resolutions.
Such resolutions may be to remove directors in whom they have no faith, or to install directors who they believe can and will manage the company in the best interests of stakeholders.
Shareholder activism should not be misconstrued as action taken only in desperate circumstances. Like any practice, it should be a constant effort, an ethic that informs every investment decision.
Placing necessary limits on corporate executives in the ordinary course of business contributes to good corporate governance.
It is for this reason, for example, that Foord Asset Management does not support unsubstantiated resolutions to place control over unissued shares in the hands of company directors, as this type of practice could lead to abuse, whether unwittingly or deliberately.
In addition to being active shareholders, understanding the long-term social, economic and geopolitical themes is crucial when building diversified, long-term portfolios.
By way of example, there is a notable socio-political response to the growing inequality divide globally.
Combined with increasingly strained public finances in most parts of the world, the likely political response in the form of higher taxes on wealth will have material impacts on many industries and companies.
Similarly, the regulatory pushback against multi-nationals shifting profits to friendlier tax jurisdictions will have to be factored in when forecasting long-term sustainable earnings.
In the South African context, the introduction of a carbon tax will also have obvious ramifications for a number of industries and large companies. Importantly, these changes will also lead to opportunities.
Staying ahead of these secular trends and positioning accordingly is an essential part of the active investment management process.
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